Offshore Investing

The phrase “offshore investing” means different things to different people. To some it conjures up images of Swiss bank accounts and Caribbean tax havens. To others it translates to visions of chasing fantastic returns in foreign stock markets. Here we’ll address both perspectives and bring some clarity to the issue.

True offshore accounts are held in a jurisdiction outside the United States. Such accounts offer a number of potential benefits, though the specifics vary from country to country.

The foremost motivation for offshore accounts is tax reduction. Generally speaking, an offshore account established for this reason will be set up in one of several countries that offer liberal tax advantages to foreign investors. However, the IRS is well aware of this tactic, and increasingly tax rules are being changed to close the most commonly exploited loopholes.

Another reason is the diversification of investments. Investing in foreign markets from within your own country (something we’ll examine next) does have limitations imposed by various laws and regulations. An offshore account generally eliminates those restrictions.

Finally, two motivations that are confined mostly to the very wealthy are asset protection and confidentiality. Protection from some forms of asset seizure can be achieved by moving those assets offshore, and some favored jurisdictions have strict corporate and financial confidentiality laws that protect information with criminal penalties.

Both of these are more frequently somewhat “shady” or questionable, though there certainly can be legitimate reasons for desiring them. For example, a wealthy individual who is slowly accumulating shares in a public company might well prefer to keep his identity as the purchaser secret, since other investors seeing a stock as “in play” are likely to bid up the price.

Offshore accounts of this type are not easy, or in many cases cheap, to set up. It will usually be necessary to form a corporation in the foreign jurisdiction, which carries its own costs both initial and ongoing. Moreover, many countries require the owner of a corporation to own property in the country in question, which adds another significant expense.

The legal and financial advisors needed are expensive as well. Finally, many offshore accounts have high minimum investments, ranging from $100,000 to $1 million or more. For all of these reasons, true offshore accounts have remained the province of the wealthy.

It is still quite possible, however, to invest in foreign markets. Many investors gaze with envy at the returns generated in some of these markets, such as the 117% increase in Thailand’s SET 100 in 2003 or the 72% gain from January to September 2005 in the Russian RTS Index. (Of course, many investors forget the downside—remember that both Asia and Russia have experienced significant financial crises as well.)

Direct investment in foreign countries (and here we’re talking strictly about what you can achieve from within the U.S. with a U.S. brokerage account) can be difficult and fraught with limitations. The first issue is what your brokerage will and will not do. It may not offer foreign investment at all, or if it does, it may offer access to a limited number of countries and companies within those countries.

There are financial concerns as well. Foreign tax and financial regulations may present unpleasant surprises when it’s time to move money into or out of the country in question—especially out of, as governments tend to look more closely at the money that leaves their borders.

Foreign trading is also subject to currency risk, since the value of the U.S. dollar relative to other currencies is constantly changing. You could make a handsome profit on a trade only to find that your gains have been eroded by a strengthening dollar.

One of the most significant investment risks centers on information and transparency. Accounting standards and financial disclosure rules vary from country to country. That means public companies may not be required to disclose as much information or as often, and when they do, different accounting rules can mean that the financials you’re seeing don’t have the same meaning that they would in the U.S.

If you prefer to avoid these risks, there are a couple of methods that will still allow you to diversify your investments into foreign markets.

One is the ADR, or American depositary receipt. An ADR is created when a U.S. bank essentially “sponsors” the stock of a foreign company, acting as an intermediary to bundle its shares and sell them on a U.S. exchange. Because the bank is exposed to risk in this process, ADRs represent solid, reputable companies that can meet the listing requirements of U.S. exchanges. Over 2,000 are available, providing a substantial range of choices.

The other avenue is the foreign ETF or mutual fund. Rather than specific foreign companies, these securities represent sectors of foreign markets, specific foreign countries, or even regions, such as Asia or Latin America. This high level of diversification can give you access to potential gains in those markets with much less risk than that associated with individual stocks or even countries.

There is certainly money to be made overseas, but the global financial marketplace is large and complex. Be certain that you fully understand the risks (and the true nature of the rewards) before you venture into it.