Putting 10 percent to 25 percent of your investment dollars in overseas stocks has long been a good idea. Rarely, though, has the argument been stronger than it was late last year. In the third quarter, returns from international stock mutual funds outpaced those of domestic funds almost 3 to 1.
Recent months serve as a reminder that a well-rounded portfolio includes international investments. The simplest solution is to find a good, low-cost international index fund. The Vanguard Total International Stock Fund, for example, sports a slim expense ratio of 0.31 percent, yet it returned 10.8 percent in the first nine months of 2005--a time when domestic stock indexes were in the low single digits. Put 75 percent to 90 percent of your portfolio in a low-cost domestic index fund and the rest in an international one like Vanguard's, and you've built your investing house on stone rather than sand. You'd be hard-pressed to beat it by casting around for hot investments or all-star stock pickers, despite what some financial advisors will claim.
The larger your portfolio gets, the more you'll be tempted to move beyond a couple of index funds. That's fine; just move in moderation. Princeton professor Burton G. Malkiel, who wrote A Random Walk Down Wall Street, suggests what he calls a core-and-satellite approach. The bulk of your portfolio--the core--remains in index funds. The satellites, meanwhile, are smaller investments that don't generally move in lock step with big U.S. indexes.
Emerging-market funds are perfect as satellites, uncorrelated as they are with the Dow Jones industrial average. The flavor of the month most recently has been emerging-market bond funds, which have performed better than virtually every asset class over the past five years. But there are plenty of other, more traditional overseas choices. Economic reforms in Japan make it appealing again for the first time in a long time, and India is just waking up to its investing potential. It's not hard to find sector mutual funds focused on either. But the 800-pound gorilla of international investing is and will continue to be China. Next month, we'll parse the options for investing in the still-Red Giant.