Modules for Beginners
Wall Street and American Stock Market
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5 things to keep in mind when investing in American stocks
Up until now, you’ve gotten an in-depth view about the American stock market, the top stocks therein, and the sectors the market is divided into. We even saw what the taxes and conversion charges were, how currency movements impact your investments, and how you can invest in the American markets.
Now, before you take that leap and begin investing in American stocks, let’s quickly look at a primer on some important things you need to keep in mind. This will better prepare you for the practical aspects involved in international investments. So, without further delay, let’s jump right into it and look at 5 things to keep in mind when you’re investing in American stocks.
1. The Liberalised Remittance Scheme
We touched upon this in an earlier chapter, remember? When it comes to investing in American stocks, the Liberalised Remittance Scheme (LRS) is of paramount importance. It’s a regulation issued by the Reserve Bank of India, and it influences your investments greatly. In fact, it holds the answer to one of the most fundamental questions you may have regarding your international investments - How much can you invest in the U.S. markets?
Before you invest in American stocks, you will need to convert Indian rupees into U.S. dollars. In other words, you need to buy dollars with Indian rupees. According to the LRS, a resident individual in India can remit up to $250,000 each financial year. This includes minors as well. So, for example, say you live in a family of four - you, your spouse, and your two children. And say both the children are minors. In this case, your family can remit up to $1 million during each financial year, since each of you is eligible to remit $250,000 individually. Of course, in the case of your minor children, the remittance needs to be countersigned by a guardian.
In the LRS rules, there is no restriction placed on the frequency of transactions during each financial year. However, the remittance limit set by the scheme is not merely for the purpose of investment alone. This quota includes various reasons for remittance, such as:
- Investment in real estate
- Investment in bank deposits
- Overseas expenses like foreign travel
- Student education costs
- Investment in securities
- Purchase of goods or services abroad
- Expenses for medical treatment in the foreign country
The above list is merely illustrative, not exhaustive. But you should get a fair idea of what it entails. Basically, remittance made for any purpose is covered within the limit of $250,000 as mentioned in the LRS. So, for instance, say you already spent $100,000 for your child’s education in the USA. Then, during that financial year, you can only remit $150,000 for investment purposes.
2. The impact of foreign exchange
Converting INR to USD is not impacted by the LRS alone. Another important phenomenon at play here is foreign exchange. You’ll recall from our earlier module on currencies and commodities that there are several factors influencing the exchange rates of different currencies. Government debt, inflation, economic status, political developments and the overall market sentiment - all of these impact foreign exchange rates.
Since these factors are constantly changing, the exchange rate between two currencies also constantly fluctuates. For instance, today, you may find that 1 USD = 72.56 INR. And tomorrow, it may change, so 1 USD = 73.33 INR. And the next day, you may find that 1 USD = 72.77 INR.
Before investing in American stocks, you need to keep the foreign exchange factor in mind. This is because when you invest in U.S. stocks, you are also essentially investing in the USD, and therefore, you’ll be bearing the risks associated with foreign currency fluctuations as well. Your investments themselves will be impacted by the USD-INR relationship. For instance, if the USD depreciates, your portfolio value will fall, whereas if the USD appreciates, your portfolio sees a boost.
3. Your taxes
In an earlier chapter in this module, you were already introduced to the details of taxation on your investments in the American markets. That is another important thing you’ll need to keep in mind when you invest in the stocks of U.S. companies. To recap, you’ll essentially be subject to two kinds of taxes:
- Tax on dividends
- Capital gains tax
If the American companies you invest in pay out dividends, you’ll be subject to taxes on those dividends in the U.S.A. As for your capital gains or the investment gains, they’re not taxed in the U.S. But they are taxed in India as LTCG and STCG. So, make sure you keep these points in mind before you invest in American stocks. The DTAA is also relevant here, since you can claim the taxes paid in the U.S. as tax credit and offset your tax liability in India. That way, you don’t need to pay taxes twice on the same income.
4. Fractional share ownership
If you have your sights set on the U.S. markets, you probably want to invest in the big ticket companies like Apple, Facebook, Alphabet and the like. But more often than not, these blue chip companies are expensive investments. Take Alphabet, for instance. One share of the company currently trades at around $2,000. In INR, at an exchange rate of around Rs. 73, one share of Alphabet costs Rs. 1,46,500!
That’s a huge sum to pay for one share. And for more retail investors, that would be well out of their investment budget. Fortunately, the American markets allow for fractional investing. So, instead of buying one whole share of a company, you can invest in a fraction of its shares - like half a share or a quarter of a share.
This brings in a great deal of ease for investors looking to invest in high-priced shares with limited funds. If you count yourself in this category, it’s a good idea to keep in mind that the American markets support fractional investing.
5. The right level of diversification
Investing in the American markets allows you to diversify your portfolio at various levels. Firstly, there is, of course, sectoral diversification. For instance, if your portfolio already includes Indian FMCG stocks, you can diversify your portfolio sectorally by choosing American stocks from a different sector, like healthcare or materials.
Secondly, investing in the American markets also gives you geographical diversification. When done right, geographical diversification can offer a great deal of stability to your portfolio. The U.S. markets also give you the opportunity to invest in emerging sectors or industries. Think electric vehicle and big chip manufacturing sectors. These emerging spaces may not be available in domestic markets, but you can invest in them via U.S. stocks.
However, while diversification is undisputedly good for your portfolio, too much diversification can be counterproductive. Your investments would then become too diluted, thereby making your returns insignificant. So, when investing in American stocks, you need to keep in mind that diversification, like all things, is best when done in moderation.
Bonus: What about repatriation of funds?
The LRS also contains provisions about the repatriation of funds. In the context of investments in the American markets, repatriation is essentially the conversion of USD earned from your investment back into INR. According to the Liberalised Remittance Scheme, if you have shares and mutual fund schemes abroad, you can retain and reinvest the income earned from those investments back in that country. In other words, it is not necessary for you to repatriate the dividends or returns on the investments made abroad.
So, for example, say you’ve earned investment gains of $500 by investing in American stocks. As per the LRS, you can then reinvest that $500 in other stocks in the U.S. markets if you wish to. You can even spend it for any other expenses abroad, if you need to. There is no mandate that you must bring those funds back into your domestic bank account.
So, that wraps up this module on the American stock markets. In case you still need some assistance before you take the leap and invest in international stocks, remember that it’s always a good idea to consult an expert and understand how those investments will align with your overall goals.
A quick recap
- When it comes to investing in American stocks, the Liberalised Remittance Scheme (LRS) is of paramount importance.
- According to the LRS, a resident individual in India can remit up to $250,000 each financial year.
- This includes minors as well.
- In the LRS rules, there is no restriction placed on the frequency of transactions during each financial year.
- Before investing in American stocks, you also need to keep the foreign exchange factor in mind.
- If the American companies you invest in pay out dividends, you’ll be subject to taxes on those dividends in the U.S.A.
- As for your capital gains or the investment gains, they’re not taxed in the U.S. But they are taxed in India as LTCG and STCG.
- The American markets also allow for fractional investing. So, instead of buying one whole share of a company, you can invest in a fraction of its shares - like half a share or a quarter of a share.
- Investing in the American markets gives you geographical diversification as well as the opportunity to invest in emerging sectors or industries.
- However, while diversification is undisputedly good for your portfolio, too much diversification can be counterproductive.
- And lastly, according to the Liberalised Remittance Scheme, if you have in shares and mutual fund schemes abroad, you can retain and reinvest the income earned from those investments back in that country.