The Common Risks You Must Know Before Investing in the US Stock Markets
Have you ever thought about how many American products we use in our regular lives?
Right from gadgets to regular use products like soaps, food items, etc., American goods and services have been occupying an important place in our lives.
With thousands of products being used across countries around the globe, the USA is home to some of the largest companies in the world. Hence, when it comes to diversifying your investment portfolio beyond the boundaries of India, the US becomes the most likely option.
There are many benefits of investing in a developed country like the US
- The US GDP is much higher than that of India. In fact, the US GDP is around 15% of the world’s GDP.
- The US stock market makes up around 55% of the global market capitalization and is far ahead of any other country. In comparison, India contributed around 3% of the global market cap.
- As per historical data, investors have a 70% chance of being a part of a rising market. Over the last century, the Dow Jones Industrial Average index has risen around 70% over the years.
- It is home to the largest stock exchange in the world – the New York Stock Exchange (NYSE)
- Benefit from exchange rate fluctuations.
- Higher trading volumes offering better liquidity.
- Access to the stocks of some of the world’s leading companies like Google, Facebook, Amazon, etc.
Apart from the benefits listed above, the obvious benefits of geographical diversification of your portfolio can help you create an investment plan that allows you a better opportunity to generate wealth. However, regardless of which country you invest in, the basic investment rule does not change: higher probability of returns = higher risks.
Hence, before you rush into buying stocks in the US market, it is important to assess the risks associated with them. Here are some risks that you need to know about:
Currency Risks
When you invest in stocks in the US from India, you are dealing in two currencies – the Indian Rupee (INR) and the US Dollar (USD). While you remit INR from your banking account, it gets converted into USD before the stocks are purchased.
Similarly, when you sell a stock in the US, the sale happens in USD but the proceeds are converted into INR before being credited to your account. Hence, a major risk faced you is the Currency Risk. Allow me to explain:
- Let’s say that you invest INR3.5 lakh in stocks in the US.
- The day you buy the stocks, the exchange rate is USD1 = INR70. Hence, you invest a sum of USD5000.
- Assuming that you buy shares of Facebook at USD250 per share, you get 20 shares in your account.
- Now, after a few months, the share price of Facebook increases to USD300 and you plan to sell all 20 shares.
- Hence, you receive USD 6000 as the sale proceeds.
- However, the exchange rate drops from INR70 to INR60 per dollar.
- Therefore, post-conversion, the sale amount translates to INR3.6 lakh – a profit of Rs.10000 only. This is excluding brokerage, commission, and taxes.
- While you booked a profit of USD1000 in the trade, the net profit position became minimal since the exchange rate changed.
This can also work in your favor. For example, if the exchange rate had increased to INR80 per dollar, then the same amount would be INR4.8 lakhs or a profit of INR1.3 lakhs!
Since it is impossible to predict the direction or magnitude of the change in exchange rates, most Indian investors looking at investing in US stocks need to be aware of the currency risks that their investments are exposed to.
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| Regular | Closes 25 Apr | ||
| Regular | - | ||
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Country Related Risks (PEST Factors)
Since we are not living in the US and have a limited understanding of the social, political, economic, and other aspects of society, estimating their impact on the stock markets can be difficult.
For example, in India, we know that every year, when the Annual Budget is announced, the markets turn highly volatile and sensitive to the smallest announcement made by the central government. Hence, we plan our investments accordingly.
We also understand the approach of various political parties and can estimate the areas where they might induce changes and how they might impact the markets. However, maintaining the same approach with the US markets can be very difficult.
So, while you might try to stay updated with all the latest news and developments in the US, not being able to accurately gauge the investor sentiment and how investors might react to a specific development can lead to an erroneous investment decision. This is another set of risks that Indian investors need to be aware of before venturing into the US stock market.
Interest Rate Risks
If you look at history, rising interest rates have always had a negative impact on stock prices. Since the US is a debt-heavy country, rising interest rates threaten the equity and fixed-income markets.
If a company is already carrying a heavy debt load or needs to take more debt for its operations, then in a rising interest rate scenario, it will be under more pressure since the cost of borrowing rises and its ability to profit and grow diminishes. This results in a negative impact on the demand and price of its stock.
Another impact of a rising interest rate regime is the impact it can have on the spending power of a company’s customers. While returns on fixed-income investments increase too, the increased cost of borrowing has a huge impact on how people spend. Hence, most companies can experience a drop in sales and profitability.
Also, when interest rates rise, investors tend to re-think their investment strategies and sell stocks that are sensitive to changes in interest rates. Higher rates attract them to fixed-income investments like bonds. This also has an adverse impact on the stock markets.
You may also want to know How to Invest in US Stocks from India
Liquidity Risks
The US stock market is the largest in the world with high trading volumes. However, this does not imply that all shares are traded in high volumes by default.
Most foreign investors assume that they will always have a seller for the stocks that they have purchased since the US markets are liquid. This can result in them ending up with stocks that have no demand left in the market.
Hence, as a prudent investor, it is important to keep an eye on the news pertaining to the companies invested in and the trading volumes of the stocks held.
Regulatory Risks
The US government has different reporting and tax regulations when it comes to the stock markets. Like in India, certain sectors in the US are governed by regulatory bodies.
Any changes made by the regulators can impact all companies in the sector and cause share prices to rise or fall. As an Indian investor, you need to stay abreast with these policy changes.
Taxability Risks
Based on the needs of the economy, the government can change tax laws pertaining to certain sectors. If the sector that you are invested in is at the receiving end of certain tax increases, then all companies can suffer and their stocks can tumble.
Also, talking about tax, as an Indian investor, you need to keep the types of taxes in mind – capital gains tax and dividend tax. You can read more about tax implications for Indian residents investing in the US stock market for details about the same.
Read More: Tax Implications for Indian Residents Investing in the US Stock Market
Quick Tips To Measure Investment Risks
There are many ways in which you can quantify investment risks:
- Beta – Beta helps you measure an investment’s volatility as compared to a benchmark index. As an Indian investor, you can measure the volatility of your US stock investments by comparing it to the BSE SENSEX using the beta coefficient.
- Analyst Ratings – While most investors are not qualified to identify all risks associated with international investments, looking at analyst ratings can be a good way to get a heads up on the market.
Summing Up
Remember, stock investments are risky. When you look at investing in a new country, it is important to ensure that you understand the risks involved in investing there.
While some basic market-related risks might sound familiar, the US, being a new market, requires a different approach to understanding them and making the right investment decisions.
Research well and try to understand the social, economic, political, and other macroeconomic factors to ensure that you can assess the risks associated with stock investments better.
Happy Investing!