5 Common Mistakes To Avoid While Investing Abroad
What are the top 5 common mistakes that we need to avoid while investing abroad?
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The US stock markets hit record highs as the market rallied into the end of 2019. The Nasdaq Composite ended 2019 on a great note by reaching the 9,000 mark for the first time ever!The prospect of making it big by investing in foreign markets lures thousands of Indian investors. While there are a plethora of success stories, many have burned their fingers. There’s never a sure-shot success formula when it comes to investing.
However, one can always mitigate risk by avoiding some of the most common mistakes. What are the top 5 common mistakes that we need to avoid while investing abroad?
Unfamiliar with the LRS Scheme:
The legal framework for the administration of foreign exchange transactions in India is provided by the Foreign Exchange Management Act (FEMA), 1999. As per FEMA, all resident individuals, including minors, are allowed to freely remit up to USD 250,000 per financial year (April – March) for any permissible current or capital account transaction or a combination of both. This scheme was introduced by FEMA in 2004 and is known as the Liberalized Remittance Scheme. In simple words, LRS allows resident individuals of India to remit (send or invest) up to $250,000 per financial year to another country for investment purposes and expenditure. This includes money that can be used to pay expenses related to traveling (private or for business), medical treatment, studying, gifts and donations, investments and so on.
Under LRS, certain types of remittances are not allowed or are subject to special controls by the RBI.
If an investor wishes to remit over $250,000 in a financial year, they are required to get special permissions from the RBI. In addition to this, under LRS, there are certain types of organizations and countries where any sort of remittance cannot take place. These are typically entities considered ‘non-cooperative’ by the Indian authorities.
Hence, if you’re an Indian resident and wish to remit money abroad, you must know about the LRS.
Tax implications for remittances vary depending on which country you’re sending the remittance from, the purpose, which country it’s going to, whether it’s a personal remittance or via a business entity, etc. If you’re not aware of the tax treatment on foreign investments, chances are high that you’re not maximizing your true earnings potential.
For an Indian Resident investing abroad, the tax will be paid in India itself. However, there is no TDS (Tax Deduction at Source) for your stock market gains, say if you’re investing in the US. Therefore, when you make money and send it back to your Indian bank account, the broker in the US does not deduct any tax on it.
However, gains within a two-year holding period are treated as short-term and are taxed at your slab rate. Gains after a two-year holding period are treated as long-term and are taxed at 20%, with the benefit of indexation. But if tax is deducted at source, say in the case of a tax on dividends, you can claim the benefit under the Double Taxation Avoidance Agreement (DTAAs) between India and the deductor country.
For example, The US and India have a DTAA. This means that you pay tax only once. For the TDS done on your dividend earnings, you get a W-8BEN form from your broker/investment partner. This form is to be filled while filing your taxes in India to show that you have already paid taxes on this income. This tax that you have already paid in the US is made available as Foreign Tax Credit and can be used to offset your income tax payable in India.
It is important to be updated on taxation when investing in the stock market. If you fail to consider the tax implications on your stock investments, you may end with much less than you planned.
Overlooking Forex Exposure:
Foreign Exchange (Forex) Exposure refers to the risk associated with the fluctuating foreign exchange rates. Forex exposure can have an adverse effect on the financial transactions which in turn can hugely affect your investment portfolio. These risks can be mitigated well through the use of hedged exchange-traded funds (ETF) or by the individual investor ensuring a well-defined portfolio diversification.
For an Indian investor investing abroad, understanding the exchange rate risk is particularly important. For instance, in the scenario where Indian Rupee is depreciating against US Dollar, investments in the cross border markets like the US can provide an additional boost to returns.In the reverse scenario where the Indian Rupee is performing against the US Dollar, an Indian investor can look at allocating more percentage of their portfolio in domestic investment avenues.
Please note that forex risk cannot be avoided altogether when investing overseas, but it can be alleviated considerably through the use of hedging techniques. That being said, transferring and withdrawing money frequently attract currency transfer charges and, hence, a buy-and-hold approach is recommended as it is more efficient than frequent trading.
Lack of proper research:
Why is it important to research stocks before investing, you ask? Well, the obvious answer is so that you don’t lose your hard-earned money. Will you even consider buying a house without ever seeing it? You shouldn’t.
Similarly, you should never consider buying shares in companies if you don't understand their business models. The best way to avoid this is to build a diversified portfolio of exchange-traded funds (ETFs) or mutual funds. If you plan on investing in individual stocks, make sure you thoroughly research the company before you invest.
Another common mistake investors often make is they get too romantic about the company they are invested in. When we see a company we've invested in do well, it's quite easy to fall in love with it and forget the fact that we bought the stock as an investment.
Always remember: one should always buy stock to make money. If any of the fundamentals that convinced you to invest in the company changes during your holding period, consider selling the stock.
Know thy brokers:
Several well known Indian brokerages have tie-ups with foreign brokers to facilitate cross border investments. An investor can open an account for foreign investment through them.Major stock brokerages in India have tie-ups with foreign brokerages that act as intermediaries to facilitate investing in international markets. In addition, there are a few foreign brokerages that have a direct presence in India via which an investor can directly invest in foreign markets without any intermediary.
No matter which broker you choose to go ahead with, the primary factors you need to consider are the brokerage fees and other charges and make sure they align with your investment capabilities and goals.
The brokerage rates differ between brokers, but typically range between $1-6 per trade. Some brokers charge a percentage rather than an absolute upfront amount.Apart from the brokerage fees, there are other 3rd party costs that an investor should expect and keep a check on such charges levied on returned checks, check to stop payments, returned wire transfers, etc which gets categorized under miscellaneous charges. Charges can also be levied on outgoing international wire transfer which ranges from $25 to as high as $50 depending on the bank with which the broker has ties.
Avoid repeating any of these common investing mistakes to ensure good returns through foreign investments.As they say “Repetition is a double-edged sword.” And if one repeats to overlook the basics, it can soon turn fatal. Make wise and informed investment decisions!
Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.