Stocks Worth Chasing

In 2006, the S&P 500 gained 14%. It was, by most accounts, a solid year for U.S. stocks.

But of the 93 international markets tracked by Thomson, that 14% gain put the United States in 84th place.

At least we beat nine countries!
That's yet more evidence that international economies are rolling. Rather than a near-term anomaly, many pros, pundits, and publications see this as a sign of the future and are recommending that you add non-U.S. equities to your portfolio.

That's smart advice.

Robert Froelich, chief investment strategist for DWS Scudder, recently told Kiplinger's Personal Finance, "I firmly believe the opportunities are going to be outside the U.S. in 2007 and beyond."

Meet Debbie Downer
But because the rest of the world's returns have been so stellar, there are a lot of performance-chasing dollars piling on.

Consider: All five of the top-performing mutual funds of 2006 were China-focused. It's no surprise, then, that foreign stock funds are ballooning in assets. Through late December, approximately $130 billion flowed into foreign stock funds -- "more than five times the amount invested in U.S. equity offerings," according to Money.

So what's a Yankee to do?
Hence our quandary: We want the best returns, but we don't want to chase performance like a desperate gambler. To avoid that, here are three options to help you (cautiously) get in the international game.

1. Index.
ETFs/index funds are inexpensive and expose you to particular countries or regions. Rather than chasing last year's hot region/country, you can place broader long-term bets. (Our Motley Fool CAPS community voted the Vanguard Emerging Markets ETF (VWO) the best for 2007. VWO's largest holdings include South Korea-based Samsung, Mexican firm America Movil (NYSE:AMX), and Russian oil giant OAO Gazprom.)

2. Know what you're buying.
Active funds have smart folks picking stocks. Also, many foreign funds have trounced their American counterparts lately. But again: Don't blindly chase last year's winners. And if you're buying funds, know what you're buying, be it managerial tenure (longer is better), expense ratio (lower is better), and whether there are loads (if there are, walk away). And last but not least, make certain you know the fund's charter.

For example, American Funds Capital Growth & Income (CWGIX) has assets of $80 billion. It's a solid fund (five stars from Morningstar), but it might not provide the world diversification you're seeking: CWGIX invests 24% of its assets in the United States, more than double its exposure to any other country.

That's because "global" or "world" funds can and do invest locally. "International" funds don't. Though CWGIX has big positions in Roche and AstraZeneca (NYSE:AZN), you'll be more familiar with these holdings:

You could be doubling down on U.S. large caps, so along with tenure, expenses, and loads, read up on where your dollars will actually go.

3. Pick your own stocks.
If you want to avoid fund fees or want to drill down on companies rather than countries, find well-run foreign businesses and buy intending to hold. Added economic and political risks mandate that you add another layer of scrutiny in your due-diligence process.

Overseas investing is higher risk, higher reward -- but as a group, foreign stocks are worth chasing.

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Brian Richards never chases whiskey with beer. Brian owns shares of Microsoft, the Vanguard Emerging Markets ETF, and the Vanguard 500 Index Fund. Microsoft is an Inside Value recommendation. AT&T is a former Stock Advisor pick. For information on the Fool's disclosure policy, click here.