Institutional investors snap up overseas issues - with good reason

How much of your portfolio should be in foreign stocks?

Hot performance in overseas stock markets is giving new relevance to an age-old question for investors: How much should you invest globally? For the typical investor, the best answer is found as part of a long-term plan and not in pursuit of short-term profits.

This year, rising values of overseas equities have been a magnet for investors. While US stock funds have returned an average of 4.8 percent so far this year, average returns on international stock funds have risen 10.1 percent. Emerging-market fund are up more than 20 percent, according to Morningstar Inc.

With gains like that, Americans have been sending lots of their mutual-fund dollars on a global tour.

Not only have strong overseas returns received extra attention from US investors, so have concerns about long-term challenges that loom for domestic investments. A record US trade deficit and huge government obligations to baby-boom retirees in years ahead, for example, have led some analysts to predict that the dollar will slump.

While investment advisers generally aren't gloomy about prospects at home, they are adding emphasis to the large share of global investment value that lies beyond US shores.

"Why shut yourself out of over half the world's capital?" says Jeremy Siegel, a finance expert at the University of Pennsylvania's Wharton School. "The developed world is going to shrink as a percentage of world [economic] output."

Siegel is not bearish on the value of the dollar. "So many people think it's going to collapse. I think that the dollar has a chance of being stable in the long run."

Whether the dollar declines or not, experts say a key virtue of global investing is that it exposes investors to a wide range of assets that do not always move in sync with one's home market. It's an example of diversification at work, smoothing out what is often a bumpy road of investing.

Financial advisers say the most critical choice an investor makes is "asset allocation," apportioning money among asset classes such as bonds, real estate, commodities, or stocks - including foreign investments. Putting one's nest egg in more than one basket is a proven way to achieve long-term goals while minimizing risks.

'There's nothing really cheap'

"The more diversification you have, the more protection you're going to have," says Sheldon Jacobs, publisher of the No-Load Fund Investor, a newsletter on mutual-fund investing. "We're really in a time when no asset classes are undervalued. There's nothing really cheap."

With foreign stocks a bit more attractively priced than domestic shares, in his view, Mr. Jacobs suggests allocating 15, 20, or even 25 percent of one's stock investments to international funds. That advice mirrors what many investment houses are counseling. But it's a target US investors haven't hit.

In 2003, for example, Americans' self-managed 401(k) accounts held about 5 percent of their funds overseas, while company-managed pension funds held about 25 percent abroad.

Since then, a tide of small-investor cash has been flowing into Asian and European markets, but experts worry that much of it could flee back home when the pendulum of performance shifts to favor US markets again.

The risk, they say, is that investors move in and out at exactly the wrong time - buying at a peak of performance and selling when they're rattled by a downturn.

"We think that in the long term international stocks should do very well, because a lot of these companies have a real opportunity for productivity growth," says Ned Notzon, who helps guide asset-allocation decisions in several broadly diversified mutual funds offered by T. Rowe Price.

Along with the potential for strong returns, he says the strategy also reduces long-term volatility in a portfolio.

Blend investments to lessen risk

This is a key selling point of diversification. According to information gathered by Vanguard, another mutual fund company, US and overseas markets posted similar overall returns from 1973 to 2003: 11.6 percent a year for US stocks, 11 percent for an index of Europe, Australasia, and Far East (EAFE) stocks. But they took their own roads to those goals. During US bear markets, when American stocks were posting average losses of 16 percent a year, EAFE stocks lost just 4.3 percent a year.

Thus, by blending those holdings, an investor could have achieved similar overall returns with less volatility or risk. This doesn't mean that overseas stocks are for everyone. The choice of how much to put overseas is one of personal comfort level.

Moreover, for US-based investors, the home market has some clear advantages. It's the largest capital market in the world. Many overseas markets, by comparison, have less-stable governments, fewer legal protections for investors, and higher costs. Still, most advisers say the benefits of foreign investing may be substantial over the long run.

"We don't want to overexpose anyone," says Brian Belski, an equity strategist for Merrill Lynch. But "we think they should get up to at least that 10 percent level," as an overseas share of the total portfolio.

Thomas Idzorek of Ibbotson Associates, a Chicago investment-research firm, recommends a more aggressive target of up to 50 percent foreign stocks, based on weighting one's personal portfolio in proportion to the value of world markets.

Still, he concedes, "That's usually far too much for US investors to stomach."

Experts also offer the following tips for people thinking about foreign investments.

• Indexing has advantages. Index mutual funds or exchange-traded funds typically charge investors less than do actively managed funds. Also, their performance can closely track an overall market - often a good thing.

• Stocks before bonds. "We do not see the value of international bond investing," says Fran Kinniry of the Vanguard Group. Not everyone agrees, but most put stocks first on the list of foreign assets to acquire.

• Don't go overboard on emerging markets. For all the talk about China, it's been one of the worst performers, for example. Again, not everyone agrees, but many say no more than 10 percent of your stocks should be in emerging markets.

• Buy in gradually. Instead of taking a sudden plunge, possibly at the wrong time, build toward your target allocation in small increments.

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