Just a few months ago, India was one of the hottest investment destinations in the world, and Indian markets were breaking one record after another. The Indian investor might well have questioned the need to invest in other countries when Indian stocks provided such stellar returns.

Today, with Indian stocks around 20 per cent off their peaks, the importance of financial diversification has become much clearer.

Put simply, it's important to put your financial eggs in a variety of baskets including countries other than India. That way if Indian investments perform relatively poorly, there is a chance that foreign investments will make up for it.

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Fortunately in recent years the Reserve Bank of India [Get Quote], RBI, has been steadily reducing restrictions on Indians investing abroad offering a range of new investment possibilities.

Investing in individual stocks

In 2007, Reliance [Get Quote] Money and ICICI [Get Quote] Direct took the lead in allowing investors the option to invest in foreign stock markets.

For example ICICI Direct, in collaboration with a large US broker, Penson Financial Services, allows you to invest in major US stock markets like the NYSE and NASDAQ which between them cover all the major US public corporations.

In addition many international companies also list on US exchanges. Apart from stocks you can also purchase exchange-traded funds and stock options.

Reliance Money has similar options and allows you to trade on both the US and UK stock exchanges.

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Both these brokerages also provide research and information services so that investors can make better informed choices when investing in new markets.

Special factors when buying foreign stocks

International share and mutual fund transactions are taxed at a higher rate compared to domestic ones.

Investors also need to take into consideration movements in foreign exchange rates. For example if the rupee rises in value, your international gains will be worth less in rupee terms.

Of course if the rupee falls, the opposite is true.

In general, international transactions are also costlier and more complicated. For example on ICICI Direct, you need to transfer money to an overseas account at Penson before trading; this can be done at any bank but will take 1-3 days and will carry a charge for converting currencies.

It's important to research foreign markets carefully, since they will often move in different directions compared to the Indian markets because of local factors.

Free finance websites like MSN Money and Yahoo Finance offer detailed information especially on US stocks and are a good place to start your own research.

Individual stocks versus mutual funds

In addition to individual stocks there are a growing number of Indian mutual funds which invest in international stocks. Buying these funds is a good way to invest abroad at lower risk and without having to do detailed research on individual companies.

However individual stocks have their advantages too. They allow investors to tailor their investments much better to their needs and interests compared to mutual funds.

For instance if you are interested in nano-technology stocks, there are many investing options on the NASDAQ and you may not find a mutual fund operating in that exact niche.

On balance it may make sense to start off with mutual funds when first investing abroad and partly switch to individual stocks if and when you feel more comfortable.

Conclusion

Recent liberalisation of investment rules has made it a lot easier for Indians to invest abroad. This not only offers a way to diversify your portfolio and reduce your risk, it also provides exciting investment opportunities not available in India.