10 Jun Debunking the Foreign Stocks and Non-Leverage Myths
Michael Sandel is a Harvard professor and he got his international fame with his lectures on justice. In the first lecture, he developed a moral dilemma case and it goes like this:
Scenario 1: You are a trolley car operator. You noticed there are five workers down the track your trolley car is traveling on. You applied the brakes but they are not working. You realised there is side track you can turn into but there was one worker on that track.
Would you steer to the side track?
Majority of the people will say ‘ýes’ and often quoting the reason that it is better to save five than to save one.
Scenario 2: There is a trolley car heading towards five workers on the track. Standing beside you is a fat man whom you know you can stop the trolley car if you would just push him down onto the track.
Would you push him?
Most would say ‘no’. What happened to the principle of it is better to save more lives than to save one?
Was it because in the second scenario you felt directly involved in the killing? At least that was what I felt.
With this in mind, let’s bust two myths in stock investing.
Myth #1 Investing in Foreign Stocks Exposes Me To Currency Risks So I Invest In Local Stocks Only
When you invest in local stocks, you are also exposed to currency risks because the companies you have invested in may have operations in other countries and transactions could be denominated in foreign currencies.
These forex gains and losses are recorded in the income statement. Not all companies hedge their currency risks and not all risks can be fully hedged. Some times hedging wrongly may result in bigger losses.
Hence, as long as you are investing in stocks you are naturally assuming a certain degree of currency risks, regardless whether the stocks are foreign or not.
Myth #2 I Am Not Taking Leverage If I Do Not Borrow Money To Invest In Stocks
Even if you do not borrow money to invest, you are actually taking leverage when you invest in stocks. This is because most companies have debts. As an equity holder, you are bearing these debt burdens. Interests are paid to debt holders before shareholders get the earnings.
If the company you are invested in collapses, the bond holders will be ahead of shareholders to claim the remnants of the company.
These debts are not assumed by you directly as the management takes care of the leverage on behalf of you. But that doesn’t mean you are not impacted by the debts in the companies you have invested in.