Investing Globally

Investing overseas has two potential benefits: performance and diversification. In 2004, for example, most major foreign markets fared better than the United States. The decade of the 1980s is another good example of a period when foreign stocks pulled ahead of their domestic counterparts. If you had invested $10,000 in the typical foreign-stock fund in January 1980 and an equal amount in a large-blend fund, the foreign portfolio would have been more rewarding over the following 10-year period. By the end of 1989, your foreign holdings would have been worth about $55,000, while the domestic-stock fund would have been worth a more modest $44,000. (Keep in mind that the decade of the 1980s wasn't a bad time to invest in any type of stocks, so returns on both foreign and domestic funds were unusually high.)

Because the performance of foreign markets depends on a host of different factors (including company profitability, trends in economic growth, interest rates, and currency movements), they generally don't march in step with the U.S. market. That means that adding some global exposure to a domestic-focused portfolio can help reduce risk, as well.

Action Plan
1) First, get a handle on how much international exposure you already have. Even if you've invested exclusively in "domestic" funds, you might have more foreign exposure than you expect. Consider  American Funds Growth Fund of America , which is one of the most widely held funds in 401(k) plans. Despite its "American" moniker, the fund actually holds about 13% of its assets in foreign stocks.  Fidelity Contrafund , which held about 17.5% of assets in foreign stocks as of September 30, is another widely held fund with above-average international exposure. While that's more the exception than the rule for domestic-oriented funds, it's still worth checking the foreign exposure of your existing holdings before adding any more. Be sure to consider individual stock holdings, as well.

Take a few minutes to enter your portfolio in Morningstar.com's Instant X-Ray. Simply type in the ticker and value for each of your holdings and click "Show Instant X-Ray." Under Asset Allocation, you'll see a breakdown of your whole portfolio showing the percentage
invested in foreign stocks, domestic stocks, and other asset classes.

You can also check out foreign exposure for an individual fund by typing the fund's name or ticker in the search box at the top of Morningstar.com's home page. (If you type in a fund name, click the appropriate ticker from the list that is generated to see the data report for that fund.) Then click on the "Portfolio" tab in the gray bar on the left side of the page. Scroll down to the middle of the page to see an asset allocation breakdown, including the percentage of assets invested in foreign stocks.

2) Decide on a target allocation to foreign investments. That's not as easy as it might sound, because even the experts disagree on the "right" amount of foreign exposure. Vanguard founder Jack Bogle contends that investors can do just fine with an all-domestic portfolio. Traditional finance theory calls for maximizing diversification by placing 20% of a portfolio in foreign stocks. Ultimately, you'll probably want to settle on a target somewhere between these two extremes.

3) Choose funds for your portfolio. While it's possible to gain some foreign exposure by buying American Depository Receipts (ADRs), which are shares of foreign companies traded on U.S. exchanges, mutual funds are the easiest way to build a diversified foreign portfolio. Our analysts have handpicked their favorite funds in each category, and looking over our list of Fund Analyst Picks for the foreign- or world-stock fund categories is a good way to get started. Fund Analyst Picks are available only to Premium Members, but you can sign up for a free trial by clicking here.

Over the past couple of years, allegations have surfaced that some fund companies allowed market-timers to exploit pricing inefficiencies by buying foreign funds after the market close and subsequently selling out for a quick profit. However, these practices have been under a lot more scrutiny lately. If a fund company has used fair-value pricing for its foreign funds or implemented redemption fees to discourage short-term traders, those are generally good signs.

4) Consider adding more specialized foreign funds to your portfolio as part of your foreign allocation. It makes sense to start out with a broadly diversified fund that focuses on bigger stocks, but some investors may also want to place part of their portfolios in small- to mid-cap foreign funds. In general, we're not big fans of regional and country-specific funds. They tend to be weighed down by high expenses, and their specialized nature can make them more volatile.

5) When you're investing overseas, be sure to look at currency exposure as part of the picture. Some foreign-stock funds always hedge their currency exposure, but most will leave at least part of their portfolios unhedged. It's not always easy to get a handle on a fund's currency hedging policies, but the portfolio manager should discuss this topic in the fund's report to shareholders on a regular basis. You can also call a fund company's shareholder-services line for more information about your fund's currency exposure.

6) Make sure to monitor your foreign holdings, as well as your portfolio's overall allocation over time. To make things easier, you can sign up for free e-mail alerts on Morningstar.com. We'll alert you to changes in your fund's performance, star rating, management, expense ratio, and more. Click here to sign up.

Learn More: Readings
Three Myths of International Investing
by Gregg Wolper

A Better Way to Size Up Foreign Investments
by Christine Benz

Morningstar's International Investing Center

Three International Funds Just Got More Attractive
by Gregg Wolper

How Shareholder-Friendly Is Your Foreign Fund?
by William Samuel Rocco

Three Funds that Invest in Japan Wisely
by Gareth Lyons