An investor who wants foreign exposure faces a basic choice. You can buy individual companies through ADRs, choosing exactly what you own, or you can buy an international fund that owns hundreds of companies for you. Neither is better in the abstract. They differ in diversification, cost structure, tax mechanics, currency handling and the amount of work you take on. This page lays those differences side by side.
Diversification
A single ADR concentrates your foreign exposure in one company, one industry and usually one country. If you hold five ADRs, a bad year for one of them is a large share of your foreign return. A broad international index fund spreads the same dollars across many companies in many countries, which reduces company-specific risk but leaves you fully exposed to the overall direction of foreign markets and currencies.
Some investors combine the two: a core fund for broad exposure and a few ADRs for companies they want to follow closely. That approach lets you study individual businesses without betting your entire international allocation on them.
Cost
The costs show up in different places.
- ADRs: Commissions on exchange-listed ADRs are often zero at major brokers. The ongoing cost is the depositary's custody fee, charged per receipt and usually deducted from dividends. The SEC's ADR bulletin cites a typical range of $20 to $50 per 1,000 ADRs. On a $50 ADR, a $0.02 annual fee is 0.04% of value; on a $5 ADR, the same fee is 0.4%. See ADR fees.
- Funds: You pay an expense ratio, deducted daily from fund assets. The SEC notes that international funds generally carry higher expenses than domestic funds, reflecting higher trading and custody costs abroad. Index ETFs are usually at the low end of the range.
Estimate what ADR custody fees cost you each year with the ADR Fee Estimator.
Withholding and the foreign tax credit
Most countries withhold tax on dividends paid to foreign shareholders. With an ADR, the depositary receives the net dividend and your broker reports the foreign tax withheld on Form 1099-DIV. In a taxable account you can generally claim the foreign tax credit for it. If your only foreign income is passive income reported on 1099s and your creditable foreign taxes are $300 or less ($600 on a joint return), the IRS lets you claim the credit without filing Form 1116.
Funds have their own route. Under Section 853 of the Internal Revenue Code, a regulated investment company (the tax category for most mutual funds and ETFs) can elect to pass foreign taxes through to its shareholders if more than 50% of the value of its total assets at the close of the tax year consists of stock or securities in foreign corporations. When it makes that election, each shareholder includes a share of the foreign tax in income and treats it as paid, which opens the door to the credit.
Key point
A broad international fund usually clears the 50% test easily. A global fund that mixes U.S. and foreign stocks may not, and then the foreign tax it pays simply reduces its returns with no credit for you. Look for the foreign tax paid figure on your 1099-DIV.
Inside an IRA, neither route produces a usable credit, because the account does not pay U.S. tax. That makes foreign withholding a pure cost there. See foreign stocks in IRAs.
Qualified dividend treatment
Dividends from an ADR can qualify for the lower qualified-dividend tax rates if the company is a qualified foreign corporation and you meet the holding-period rule. IRS guidance treats ADRs listed on a U.S. national exchange or Nasdaq as readily tradable, which satisfies one path to qualification; companies eligible for a comprehensive U.S. tax treaty can qualify by that route. Funds report the qualified portion of their distributions for you. The details are in qualified dividends on foreign stocks.
Currency
Both structures carry currency risk. An ADR's dollar price reflects the home price times the exchange rate, so a weaker foreign currency lowers it. An unhedged international fund behaves the same way across all its holdings. The difference is choice: you can buy a currency-hedged fund if you want to reduce that exposure, while individual ADR holders rarely hedge. Our page on currency risk works through an example.
Control and effort
| Factor | Individual ADRs | International ETF or fund |
|---|---|---|
| Diversification | Concentrated in your picks | Broad across companies and countries |
| Ongoing cost | Depositary custody fees per receipt | Expense ratio on assets |
| Foreign tax credit | Directly, from 1099-DIV | Only if the fund makes the pass-through election |
| Currency | Unhedged | Hedged or unhedged, by fund choice |
| Control | You choose every holding and when to sell | Manager or index decides; you control only the fund position |
| Research effort | High: annual reports, filings, news | Low: read the prospectus and holdings |
| Capital gains | Realized only when you sell | Funds may distribute gains; ETFs often distribute fewer |
Control matters for taxes, too. With individual ADRs you decide when to realize a gain or harvest a loss. A fund makes its own trades, though ETFs generally distribute fewer capital gains than traditional mutual funds.
Corporate events are another consideration. ADR programs are occasionally terminated or delisted, leaving holders to choose between receiving the underlying shares or cash from the depositary's sale. A fund absorbs those events internally. See ADR terminations and delistings.
Which fits
Funds suit investors who want broad foreign exposure with little maintenance. Individual ADRs suit investors who want to own specific businesses and are willing to read foreign filings, track fees and monitor withholding. Many people use both. If you are unsure how a structure will be taxed in your situation, a tax professional can review your 1099s and tell you which credits apply. For other ways to buy foreign shares, see how to buy foreign stocks.
Common questions
Can I claim a foreign tax credit for taxes paid inside an international fund?
Possibly. A U.S. fund that holds more than 50% of its total assets in foreign corporations' stock or securities at the close of its tax year may elect to pass foreign taxes through to shareholders. If it does, your Form 1099-DIV will show your share of foreign tax paid, which you can then use for the credit or deduction.
Are ADR fees higher than an ETF's expense ratio?
It depends on the program and the fund. ADR custody fees are charged per receipt, so their percentage cost depends on the ADR's price. A fund's expense ratio is a percentage of assets. Compare both as a percentage of your position.
Do international ETFs hold ADRs?
Some do, particularly funds that track indexes of U.S.-listed ADRs. Many broad international funds instead hold the home-market shares directly. The prospectus and holdings list will tell you which.
Sources
Educational content only, not investment, tax or legal advice. The Stateside Report does not recommend buying or selling any security. Tax rules depend on your situation; confirm with a qualified tax professional. Full disclosures.