How to buy foreign stocks

Legendary value investor John Templeton's philosophy was to 'search among many markets for the companies selling for the smallest fraction of their true worth'. There are many benefits to investing internationally, not least of which is a more diversified portfolio. You also have access to more opportunities, industries and markets that simply don't exist in Australia. And, despite recent falls, the Aussie dollar is still well above historical averages meaning you get more bang for your buck. It's a fantastic time to invest overseas.

If you've never bought a foreign stock and don't intend to, there's no need to read on. If you've considered it but don't know how, this practical guide will set you on your way.

First, you need to choose an online broker. Choices include CommSec's Pershing account, Westpac's Global Markets account, E*Trade, St George direct shares, ANZ's international trading account, Saxo and Interactive Brokers. No doubt there are more, and we'd love the benefit of your experience in the comments section below.

The first two run on the Pershing platform whilst the following three are variations of E*Trade. That means you don't have as many choices as it looks. To reduce the hassle of switching, you might prefer the international offering of your existing broker. If you're starting afresh, E*Trade is generally cheaper with a better sign- up process, but as you'll read further on Interactive Brokers should be seriously considered. See A world of opportunity: Your overseas investing survival guide for a more comprehensive list of what to consider when choosing a broker.

No pain, no gain

The next and most arduous step is to create and access your international trading account (for now we'll assume you have either a CommSec or E*Trade account). Steel yourself before getting started or it won't be long before exasperation takes hold.

CommSec application forms need to be printed off—they can't be submitted online. As well as basic personal details, you'll need your CommSec login number and some certified identification documents.

Then there's the W8-BEN form, used by the US's Internal Revenue Service to prove you're a 'non-resident alien' for tax withholding purposes. Uncle Sam, like most bureaucrats, is a pedantic nit-picker. After writing 'myself' as the capacity in which I was acting, the form was returned with a big red cross on it and 'SELF' helpfully printed on a replacement. Glad they cleared that up—I'm too young for an identity crisis.

A new account will appear in your ordinary CommSec account soon after you've submitted your application. You can ignore it. To access your new global trading account, log into the Pershing website, not CommSec, a reasonably important point one would have thought CommSec should communicate. Find the link by following the menus through 'Trading', 'Orders' and then 'International shares' in your ordinary CommSec account.

Login details for the Pershing website will be sent in two separate letters. The first will contain your Pershing trading account number, written in the form of 0AC-123456. The second contains your password.

When logging in for the first time, remember that the first three characters of your account number is your financial organisation number, and that you enter your account number as 0AC-123456, without the hyphen. To make it a little more fun, you're left to figure this out for yourself.

Don't relax just yet, you're not quite done. For increased 'security' you must answer four completely inane questions. For CommSec, knowing your dream job is central to determining who you are. More sensible websites ask the name of your first guinea pig, which, by comparison, seems the embodiment of sanity.

Lastly, you must type in a secret phrase and choose a picture that will display when you log in to verify you're not on a fake website. If you're short of ideas, Franz Kafka images can be found here.

The reason I left CommSec's Pershing service is because the fees are outrageous. While Interactive Brokers offers nominal trading costs and currency exchanges, Pershing's currency transactions can also take more than a day or two to clear (depending on which currency, some currency trades at Interactive Brokers happen in seconds) and I once woke up to find out that I'd been had for over $400 in brokerage to sell a small stock in numerous tiny parcels. That was the final straw. It was a substandard service offered at a premium price, which is why so many superior services have appeared more recently.  

With the nitpickers vanquished and your dream job of forger now established, you're ready to trade with CommSec, err, Pershing, err CommSec via Pershing. Well, you know what we mean.

E*trade is easier

To access the application form for E*Trade's Global Shares product, login to the website and click on the 'Products' tab, then 'Shares', 'Global Shares' and 'Activate Now'. Again, these forms need to be printed off.

After filling in your name, your existing E*Trade account number and attaching your certified documents, mail off the form and you're done. Well, you might be.

If you receive an email telling you your account is activated, you'll be able to trade Australian and international stocks from your existing account. I didn't. After a month of waiting for my E*Trade account details, it turned out they hadn't bothered to tell me they needed some more information—not my dream job though.

Ready to trade

Before you can trade, you'll need funds in your account. CommSec, not wanting to part with tradition, makes things difficult. You have to call them and ask for funds to be transferred from your nominated bank account into your Pershing account, which takes two business days (if you call before 11am you save a day). One advantage of this is that you're able to hold foreign currencies, although these don't earn interest (not that you'd be missing out on much at the moment).

An E*Trade account, on the other hand, comes with a dedicated Australian dollar bank account, although interest rates are paltry for balances below $50,000. When you buy international stocks the account is debited and the cash is automatically converted to the correct currency. It's far easier than the CommSec carrier pigeon approach.

A foreign exchange 'buffer' of 2% is also added to all E*Trade purchases. This is a margin of safety that ensures there is enough cash to execute purchases should exchange rates fluctuate before the trade is filled. The actual rate you pay doesn't include this buffer.

Trading itself is a simple matter. Though the CommSec Pershing website is a little different to the normal CommSec one, it's easy to use and place trades.

E*Trade is even better: trading is exactly the same for Australian and international shares, and you can access overseas markets by clicking the 'Global Shares' tab on the trading page.

But wait, there's fees

Disappointingly, neither E*Trade nor CommSec disclose all the fees associated with overseas trading in the one place. Though the fees are difficult to find on the websites, you can be sure you'll find them on your trading statements. It's always worth making a call to your broker just to make sure what you'll be charged.

Brokerage for overseas markets is significantly more expensive than for Australian stocks (see Table 1). While a trade of less than $10,000 will set you back about $20 for an ASX listed stock, be prepared to pay the greater of US$65 or 0.75% of the value of your trade using Pershing, and the greater of $59 or 0.59% using E*Trade.

But the fees don't stop there. You'll also incur fees when exchanging cash from Australian dollars to foreign currencies. CommSec's fee varies depending on the cost of exchanging wholesale sums of money, and 25-30 basis points is typical for major currencies (a basis point is 1/100th of 1% so 30 basis points equals 0.3%).

E*Trade's maximum fee for changing currency is 60 basis points. Although it was difficult to get a straight answer, I was told this might go as low as 30 basis points if you're lucky.

Some individual stock exchanges also levy their own fees, which are then passed on to customers. Ones to watch out for are the London Stock Exchange, which applies stamp duty of 50 basis points on purchases, and the Canadian Stock Exchange, which charges a flat fee of CAD0.015 per share, regardless of their value.

Both CommSec and E*trade allow you to participate in major European, Asian and US markets, with CommSec having an even more extensive range of options if you're prepared to make your trades over the phone.

CommSec also charges some extra fees. If you hold stocks or cash in your Pershing account and don't trade during a calendar year you'll be stung for $68.

Having trade confirmations mailed to you will cost $1.80, and there is a foreign securities custody fee of $2 per security per month for non-US holdings.

In short, an absolute minimum of about 1% of your investment will go towards fees when trading international stocks, and more for smaller trades or markets. Though this is ten times the 11 or 12 basis points you'll pay for a large trade on the ASX, it still isn't significant if you're buying shares for the long term.

Interactive Brokers

Initial research into overseas brokerage options led us to rule out Interactive Brokers. It seemed complex, opening an account was difficult, and there were reports of poor user experiences.

But we were wrong. A Streets Paddle Pop costs more than a stock or foreign exchange transaction on Interactive Brokers, and other advantages mean it's preferable to E*Trade or Pershing.

The paperwork takes half an hour or so to complete and is quite straightforward. Unlike other brokers, you can also complete the W8-BEN form online simply by entering your name as a proxy for your signature.

You'll also need copies of two documents to verify your address (I used a bank statement and a recent tax return notification) and two more to verify your identity (my passport and license). One of the documents in each pair must be certified as a genuine copy of the original document.

Once that's done, you'll need to deposit the Aussie equivalent of a minimum of US$10,000 in your new account, the quickest way being the 'Pay Anyone' feature in your online bank account. Once Interactive Brokers receives your certified documents, you'll soon receive an email saying you're ready to trade.

How it works

There's no getting away from the overwhelming nature of the first screen after you login. Interactive Brokers is designed for professional traders and money managers and it shows. Each area of the screen is dedicated to a particular function, including showing the Aussie dollar amount deposited in your account [Note that if you want to trade in markets other than the US, the website says it's easy to add them later on].

If you want to buy a US stock, you'll have to convert your Aussie dollars to US dollars first, which is a simple and cheap process—just US$2.50. And no, that's not a typo. It's also lightning quick. Remember Pershing can make you wait two days to trade and makes a fat margin on the currency exchange. There's none of that with Interactive Brokers.

To open the FX Trader module, select 'New window' at the top of your screen, then select 'More advanced tools' at the bottom of the list. Finally, select 'FXTrader'. Because it's not one of the currency pairs that appears automatically, you'll need to add AUD.USD to the blank box. Simply double-click on the area where the description belongs and type in AUD.USD.

You should now see the currency pair in the top left hand corner of your screen under the heading 'Contract'. To convert your AUD to USD, right mouse click on the currency pair and you'll see an option for 'Trade'. After that, just type in the dollar amounts before executing the trade. Within an instant you should see your account details change to reflect the trade on your original work screen (i.e. not within the FXTrader module).

Now you're ready to buy a stock. Use the 'Order Entry' box on the left hand side of your original screen and make sure you use price limits at all times. That's particularly the case if you're opening a trade to execute while you're sleeping.

To see details of your completed trades, select 'Account' at the top of the screen, select 'Activity' and then 'Activity Statement'. Then it's just a matter of typing in the relevant dates. This is only a fraction of what this service can do. You can trade just about any market in the financial world but, unless you have an expertise in Portuguese swaptions, we don't recommend it. Same goes for the margin trading facility.

The system takes a day or two to get used to but with trading costs this low, who cares? A little investment in time could save you thousands over the years. Plus you control everything, unlike foreign exchange trades at Pershing, for example. It really is quite impressive.

Just note that you'll be charged a maximum of US$120 per year if you don't make enough transactions, but this is more than fair given the quality and cost of the service. Interactive Brokers is also a listed company in the US and the CEO is worth listening to if you manage to google and interview with him.

OptionsExpress

OptionsExpress is also a low-cost alternative but focuses on products exclusively tailored to the US financial markets. It's most competitive on costs in the US options markets but you can get quotes on stocks and futures, too.

Unless you're opening a margin loan account (again, not recommend), there are no minimum requirements. An Australian driver's license or passport will do, verified by post. Accounts are activated the next trading day after their receipt. With an Australian operation, your account can be quickly operational.

As with Interactive Brokers (but unlike Pershing) OptionsExpress charges according to the number of shares you buy. If you buy 1–1,000 shares, a standard commission of $14.95 will be charged. More than a thousand shares costs an investor $0.015 per share.

In the terrifying event your online broker goes broke, Interactive Brokers and OptionsExpress are protected by the US-based Securities Investor Protection Corporation (SIPC). US law requires both brokers to insure client accounts.

Both are insured well above the minimum requirements of around $100,000 per account. Interactive Brokers is insured up to $500,000 per account—guaranteed by the SIPC—while OptionsExpress can insure above $500,000 depending on the composition of your portfolio. We highly recommend consulting the respective companies for further details.

If you're only going to buy or sell stocks a few times a year and you're prepared to stomach the high costs associated with E*Trade or Pershing, then you might feel more comfortable sticking with them. They're familiar brands with straightforward websites.

But if you're going to invest overseas regularly, Interactive Brokers and OptionsExpress are worth considering. I'm $5,000 poorer for relying on the 'convenience and familiarity' of Pershing over the five year period I used it. With that sort of cost saving on offer, I'm more than happy to switch.

With only 2% of the world's listed businesses, buying only Australian stocks limits you to 2% of the opportunities. The launch of Share Advisor Premium means we now offer ongoing coverage of our very best stock ideas from home and overseas. And thankfully, it's never been easier to invest abroad.

Note: The above information is accurate to the best of our knowledge, but we aren't experts with these services and things may have changed since our initial research. If you are in any doubt about the services offered and your financial protection, please consult the service providers directly. And we'd love to hear any experiences you've had with online international brokers in the comments section below. 

Note: esuperfund administers my SMSF and, as it has a relationship with Saxo, I was forced to close my Interactive Brokers account. This was a great disappointment, as Saxo offers an inferior service and the foreign currency exchange rates are disgusting. Given esuperfund's focus on minimising costs I'm dumbstruck by their choice of Saxo.