Personal Finance International stock funds worth a look for 401(k)

By David Pitt

AP Personal Finance Writer

DES MOINES, Iowa (AP) -- We're reminded daily that we live in a global economy. Yet as investors we often limit our thinking to the United States.

Anyone wanting a well-rounded portfolio must consider international mutual funds as a diversification tool. The movement of international stock markets isn't closely correlated to what's happening on Wall Street. So investors can lessen the possible impact of a slump in the U.S. by investing abroad.

Plus the math is pretty simple. The value of foreign company stocks accounts for more than half of the world's market capitalization, so ignoring companies outside the U.S. is eliminating significant investment opportunity.

Still, investors may be put off by the headlines about the debt crises in Greece and Portugal last year. Mounting debt is slowing the growth of the U.S. economy as well as those of several developed nations, so many pros are focusing on rapidly expanding economies, said J. Michael Martin, chief investment officer of Financial Advantage Inc., in Columbia, Md.

"We live in a culture where we've built this debt that's going to slow us down," Martin said. "So you might as well diversify into the countries where the opportunity is very big."

There are several types of international funds to choose from. They're usually broken down like this:

--Global Funds (World Funds): They invest primarily in U.S. companies doing business globally. They're generally the most stable option among funds that offer international exposure.

--International Funds: They may be called diversified international funds or sometimes foreign funds. They can invest in U.S. companies, but typically invest mostly in countries with mature economies such as Japan, England, and France. However, most put at least some money in emerging markets. International funds are categorized much like U.S. domestic funds by market capitalization: small- mid-, and large-cap. They also are separated into familiar investment styles -- value, growth, and blend.

--Country-Specific or Regional Funds: There are funds dedicated to particular regions such as Europe or Latin America. There are funds even more specifically invested in one nation such as Japan. These funds can be very volatile because they're tied closely to one nation's economic and political environment. An inexperienced investor may want limit their investment or stick with more diversified funds.

--Emerging Market Funds: Invest mostly in companies located in developing economies such as China, India, and Brazil. Some of the hottest stock funds in the past year are those tied to emerging markets where companies are profiting from the expansion.

Indeed the hottest category at the moment is emerging market funds.

They attracted a record amount of new money last year, nearly $96 billion, according to fund research firm EPFR Global. That was ahead of 2009, when flows were $83 billion.

The attention came because investors were chasing performance.

The iShares MSCI Emerging Markets Index Fund (EEM), an exchange-traded fund that tracks an index of large-cap companies, returned more than 70 percent in 2009. The index includes stocks such as, South Korea's Samsung Electronics Co., Brazil's Petroleo Brasileiro SA and Taiwan Semiconductor Manufacturing.

Last year the fund posted more modest, but still worthwhile returns of 16 percent.

Although those numbers are attractive, early investors weren't spared when the U.S. market tumbled in 2008. The widespread worries of a global recession caused the fund to lose half its value.

That underscores the volatility of these funds. Although it's a mistake to invest purely on past results, there still may be a place for international stocks in your mix of 401(k) investments.

However, you may encounter a roadblock.

In particular, the option to invest in an emerging market fund is limited within 401(k) plans. Only about 20 percent offer emerging market funds, said Pam Hess, director of retirement research for business consultant Aon Hewitt.

When these funds are available, 30 percent of plan participants use them and allocate an average 18 percent of their portfolio.

Companies often avoid dedicated emerging market funds precisely because of their volatility.

Yet these funds are expected to continue to attract more money this year as investors recover some willingness to take risk. But they may proceed with more caution as inflation risks increase, said Cameron Brandt, EPFR Global's senior global markets analyst.

"The question of what inflation is going to do to these markets and what kind of policy responses it's going to trigger has definitely got some investors, not exactly spooked, but sort of kicking the tires again," said Brandt.

Advisers are quick to caution against becoming too enamored with the potential return and to maintain balance when investing in emerging markets.

The choice may pay off in the long run, but there's more risk for these funds to have a steeper drop when the market goes down, said Gregg Wolper, a senior mutual fund analyst for Morningstar Inc.

When that happens, many get scared and pull their money out. This locks in their losses and they miss the opportunity to recover.

For many 401(k) investors the best way to put money into emerging markets is by selecting a broader international stock fund that may invest in some emerging markets. About 90 percent of 401(k) plans offer such an option.

Precisely how much of an international fund's portfolio will be invested in emerging markets, can vary widely, but is often around 10 percent.

The bottom line for 401(k) investors is to certainly consider an international fund to help further diversify your portfolio. If you have a separate emerging market fund option, it's worth considering, but don't go too far.

And don't be afraid to ask for help. Your 401(k) plan may offer access to and adviser. Seek guidance on how you might realign your investment choices to add an international fund without disrupting your overall goals.

Published: Tue, Jan 25, 2011

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