Foreign Investments Can Pay but May Be Risky
Q: Now that interest rates in the United States are at their lowest point in decades, investments in foreign stocks, bonds and international income funds are being heavily marketed as a way to increase the earning power of our money. For example, I am told that Canadian certificates of deposit are paying nearly 2% to 3% more than accounts here, and they are insured up to $60,000. Surely, there must be some risk associated with these investments. Can you explain? --T.R.
A: You know what aerobics teachers tell their classes? No pain, no gain. Well, investment advisers have a similar saying: Reward equals risk. In both instances, you can’t expect one without the other.
As you noted, the rewards of foreign investing can be substantial. On the average, says Jon Markese, director of research for the American Assn. of Individual Investors in Chicago, foreign investments can offer returns about 2% higher than those in the United States. But they carry greater risks.
One of the riskiest strategies--although potentially one of the most rewarding--is a direct deposit in a foreign currency denomination product, such as the Canadian certificate of deposit you are considering. While these products may offer higher yields, those returns could be entirely erased--and even worse, your principal could be eroded--if the exchange rate between the foreign currency and the U.S. dollar is unfavorable at the time you cash out your investment.
“Any yield advantage can be lost to a foreign currency fluctuation,” explains Helen Johnstone of Morningstar, a Chicago mutual fund analysis service.
“And the problem is that you can’t very well anticipate those fluctuations months or years in advance,” Johnstone adds.
Both Markese and Johnstone advise all but the most sophisticated investors to stick to investments in “dollar denomination assets”--a fancy way of saying investments that are bought and sold in U.S. currency. This way you avoid the headaches and risk of currency fluctuations. However, your returns are also lower than if you were to invest directly in a foreign currency.
Markese and Johnstone also recommend that all but the most sophisticated investors stick to mutual funds. Some of these funds, going under the name global, invest in the United States as well as abroad. Global funds tend to be more stable and less risky--and less rewarding. More risky--and rewarding--are “foreign” funds, which invest only in non-U.S. instruments.
There are plenty of mutual funds to consider. All the major mutual fund managers, including Dreyfus and Fidelity, offer international funds, both “global” and “foreign.” Many funds charge sign-up fees, or “loads,” that can be substantial. However, there are no-load funds as well. Both Morningstar and Lipper Analytical Services rate mutual funds based on past performance. Their surveys are available in many public libraries.
Despite the greater risk associated with international investing, both Markese and Johnstone say they are a welcome addition to a well-balanced portfolio. At no time should an average investor put all of his dollars in any single investment--especially a foreign one.
Writing Off Loss From Investing Can Be Tricky
Q: I hold several Pan American bonds that I believe are now worthless given the insolvency of the airline. They are no longer quoted on the New York Stock Exchange, and my broker said I would not get enough on any sale to even cover his commission. May I just write these off on my taxes for 1991? I definitely think I have suffered a capital loss. --H.R.
A: The Internal Revenue Service has no set rules on when you can declare a capital loss. The only guideline aiding taxpayers is that the loss must be declared when it can be “reasonably determined” that the investment is “wholly worthless.” If the investment has any residual value, or if there remains a reasonable chance that the investment could be salvaged, the taxpayer cannot declare a loss.
Do Pan Am bonds qualify as “wholly worthless”? Perhaps. But make your decision carefully. If you are overly pessimistic, the government can penalize you for your error in judgment. However, if you wait too long to declare your investment worthless, you could lose the writeoff entirely--because the IRS imposes a three-year statute of limitations on capital loss deductions.
Whatever you decide, you should be prepared to support your conclusion if challenged by the IRS.
How do you make the deduction? You are allowed to write off the full extent of any investment losses in a single year against your investment gains. If your losses exceed your gains, you may use the excess loss as an offset against ordinary income--up to $3,000.
Any remaining capital loss must be held over to following years, when it can be used in the same fashion.
