By September 2002, U.S. investors had poured $370 billion into funds that primarily buy stocks of foreign companies.

What's the attraction? Alluring returns, for one. In 1999, for example, the average foreign-stock fund gained a phenomenal 44%, while the S&P 500 rose only about half as much. What's more, foreign investing offers sought-after diversification. As we discussed in Lesson 301: Why Diversify?, if you own a variety of investments, chances are you'll always have a hand in something that's performing well.

Unless you understand how to evaluate these funds, though, investing abroad can be pretty harrowing. The key to smart foreign-fund investing comes down to looking beyond returns and Morningstar ratings and understanding how your fund invests. By doing so, you will be able to set reasonable expectations for the investment and uncover its hidden risks—and avoid surprises. Start by asking the following two questions. You can find most of the answers to these questions on the Morningstar Fund Report, on the fund family's Web site, or in the fund's shareholder report.

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