The Japanese economy is the third-largest in the world, trailing only the United States and China. A market that size is one that many investors, understandably, don’t want to ignore. Here’s an overview of the Japanese stock market, as well as its investments, risks and requirements. Consider working with a financial advisor as you explore ways to diversify by investing in non-U.S. economies such as Japan’s.
Japan’s Stock Market and the Nikkei
Japan’s major stock exchange merged with 10 other Japanese stock exchanges in 1943. After World War II, it reorganized and became the Tokyo Stock Exchange in May 1949. It’s now the third-largest stock exchange in the world, with a market capitalization of $5.68 trillion as of the writing of this article. Some of the best-known companies in the world have their homes on the Tokyo Stock Exchange, like Toyota, Honda and Sony.
The Nikkei 225 stock index is the equivalent of the U.S. Dow Jones Industrial Average (DJIA). It contains 225 large, blue-chip stocks, representing the Japanese stock market. The Nikkei is a price-weighted index just like the DJIA. Companies are ranked by stock price instead of market capitalization.
During Japan’s decade of high growth in the 1980s, the Nikkei reached a high of about 38,000. By 2009, due to Japan’s economic problems, it closed at a little over 7,000. Now, in 2021, it is trading around 30,400.
Investing in Japan Through ADRs and ETFs
It’s often the case in international investing, that American Depository Receipts (ADRs) and exchange-traded funds (ETFs) are the most convenient ways to gain access to some of the stocks publicly traded in a foreign country. This is the case for Japan as well.
ADRs are depository receipts issued by Japanese companies that can be purchased through your brokerage and traded on U.S. stock exchanges. ADRs are not actual shares in a Japanese company. They represent blocks of shares held by a bank. Most also offer a dividend payout and occasionally voting rights.
Even though it’s tempting to purchase ADRs for your favorite Japanese company, Toyota or Nissan, for example, ADRs may also have serious tax implications. Before purchasing, check with your CPA and let them explain the tax consequences for you.
It may, instead, be best to invest in one or more Japanese ETFs. ETFs are baskets of securities much like mutual funds. They trade throughout the day on the exchanges but have some of the qualities of mutual funds like being composed of a basket of securities. You can find ETFs, which hold equities, fixed-income securities and more, including those in the currency and commodities markets.
There are a handful of ETFs traded in U.S. markets that make gaining exposure to Japan even easier. In addition, you can invest in one or more ETFs that track the performance of the Japanese market index.
Investing in Japanese Stock Markets
If you want access to the Japanese markets directly, there are a few steps you have to take. First, the stocks are all denominated in the Japanese currency, the yen. It makes hedging in U.S. dollars necessary when you make a trade due to currency risk.
Here are the steps to invest directly in Japanese markets:
- Open an international trading account with an international stockbroker. Some choices are SaxoBank, Interactive Brokers, Fidelity and TD Ameritrade. Alternatively, open an account with a Japanese broker, but only if you speak Japanese. The majority of the Japanese do not speak English, even for business purposes.
- Fund your trading account. Check to determine if there is a minimum balance required and, if so, how much it is.
- The amount you must purchase from a Japan-based exchange is different than in the U.S. You have to purchase a minimum block of 100 shares of many companies, but check and see what the minimum purchase is for the companies in which you have an interest.
- The Tokyo Stock Exchange identifies stocks by four-digit numbers. Find the number for the stock you want to trade.
- Start trading. You may only be able to place a limit order although that rule has relaxed some in the recent past.
- Since all trades are denominated in Japanese yen, you will have foreign exchange risk which can be offset by a hedge in U.S. dollars.
Opportunities and Risks of Investing in Japan
Good investors take advantage of opportunities that arise in the market. Just as the U.S. has its own incoming strengths, Japan is similarly a hotbed for opportunity. Here are some things to keep an eye out for:
- Due to the impact of Abenomics in Japan, the Japanese markets may roar ahead once the pandemic abates.
- You’ll have access to some of the largest and most well-capitalized companies in the world, particularly in the automotive and electronics sectors.
- Japanese stocks are usually very affordable. Warren Buffett took a position in several Japanese trading companies in 2020. Since he’s usually a value investor, he’s investing in relatively cheap Japanese stocks.
Additionally, investing will always come with its fair share of risk. Here are some things to watch out for when investing in Japan:
- There is no guarantee that the Japanese markets are going to continue to recover post-pandemic.
- Japan has an uncertain economic future. The markets there were phenomenal in the 1980s, but for the next two decades that was not the case.
- There is currency risk with every trade you make unless you hedge in U.S. dollars.
- As a foreign investor, you may find high transactions costs.
Many investors find investing in Japan perplexing, at least at this time. Investing in an ETF may be the best way to go unless you’re a high-net-worth individual. In that case, you may be willing to take on more risk. It’s also difficult to gain access to Japanese stockbrokers for assistance since chances are they don’t speak English.
If you’re interested in foreign investing, it may be easier to start closer to home. Investing in Canada is a well-built process for Americans, as the two countries have a longstanding relationship. On the flip side, investing in Canada doesn’t present the same opportunities as Japan.
Tips for Investing
- Do you need help with your investment strategy? A financial advisor can explain your options. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you book gains on your Japanese investments you’ll need to calculate your capital gains. Our capital gains calculator will help you determine how much you may owe in taxes when you sell your shares.
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