US stock market investing downsides
Investing in the American share market does bring some interesting advantages like fractional share buying, diversification of portfolio participation in a quality array of companies. However, investing in the US stocks or even in the US market index is fraught with its own set of risks. After all, your ability to handle and manage the risks are much lesser compared to Indian stocks. Information is also not as easily accessible and most of the research is from the perspective of US investors.
When you invest in the US stocks through the American stock exchange, you are open to a number of risks at a micro and macro level. Apart from all these, there is the currency translation risk and the risk of dual regulation that you are subjected to. So, whey you invest US stocks, make it a point to be aware of these risks, since at the end of the day, it is the risk adjusted returns that really matter to you.
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Major risk factors when you invest in the US markets
As an Indian investor who is investing in the US markets, there are a number of potent risks that you need to be conscious about. Here is a summary of the key risks that you are exposed to.
- The first risk that you are exposed to is the familiarity risk. You are not obviously not as familiar with companies like IBM, Exxon and Microsoft as your familiar with stocks like Tata Steel, Reliance and Infosys. It is all about the trust and familiarity that you enjoy in these stocks. In the US markets, you are always exposed to the familiarity risk.
- Most US market research is from the perspective of US investors and not from the perspective of Indian investors, since they constitute a very small part of the overall US investment corpus. Thus what may seem like a return factor to the US investor may actually be a risk factor for the Indian investor. You need to take this differential into account.
- Currency translation risk is a major risk you are exposed to when investing in US stocks. You need to convert rupees and dollars twice. Once you are invested in the US stocks, a strong dollar and a weak rupee are more meaningful for you as you get more rupees per dollar earned. For instance, if you earn 10% in the US markets in the year and if the dollar has appreciated by 5% in the year then your effective returns in rupee terms is around 15%. The reverse situation is a risk factor as it can dilute your effective returns.
- There is a country specific risk that you get exposed to. US regulation and US policy can undergo rapid changes. For instance, US policy became extremely inward looking when Trump took charge in 2016. Things have changed since Biden came in as the President of the US, but these changes are fluid and can have a deep impact on how the US government views Indian investors. Macros risks in the US market can also arise from factors like changes in tax laws, too much debt owed by the US government, loose monetary policy, spike in interest rates, lower consumption etc.
- When you invest in the global market, you get exposed to the US market cycles. For instance, in the US, the Dow has bounced back sharply from the year lows. However, the NASDAQ is still about 25% away from the highs of the year. This creates a discrepancy since your portfolio performance would be impacted based on your portfolio mix.
- Tax risk is a major risk. For instance, currently, capital gains are tax free in the US while dividends are taxed at 25%. For instance, a policy change like the US deciding to tax capital gains or increasing the tax on dividends can have a deep impact on the returns on your portfolio net of taxes.
- There is the allocation risk. Normally, it is advisable to have about 10-12% of your portfolio. Suppose, the Indian markets are tepid and the US markets rally sharply, then you could have a situation wherein your exposure to the US market may increase very sharply. Reverting that may take time and can also incur tax and currency costs.
- Lastly, there is the liquidity risk in US markets. Money takes cannot be realized in 1 or 2 days like in the case of Indian bonds and stocks. To realize the funds after currency conversion can take up to 10 days, and that can be a key liquidity risk factor.
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