The Biggest Danger in Investing Overseas

Smart investors have seen the potential of international investments for years. If you're not careful about how you invest abroad, however, you may end up with a much different international portfolio than you expect -- or want.

Making it easy
One challenge to international investing used to be that it was difficult logistically to buy investments abroad. Without a foreign brokerage account, you were limited to just the companies that chose to list their shares on U.S. stock exchanges.

Now, though, the opportunities to invest abroad are almost limitless. Hundreds of mutual funds and ETFs give you the chance to build a diversified international portfolio easily. Increasingly, discount brokers are allowing their clients to trade foreign stocks directly, with access to foreign stock exchanges becoming more commonplace. But along with all of those vehicles for investing abroad, there's a big danger you simply can't ignore.

Getting out of the country
It's not that foreign investing is a bad idea. From the standpoint of diversification, investing abroad makes a lot of sense. Think about it:

  • If you're worried that the fiscal problems that the U.S. government is currently having will continue to put a drag on economic growth, then turning to more fiscally responsible areas around the world will let you focus on the potential winners from the financial crisis.
  • Scared that the U.S. dollar will lose value in the future? Foreign investments can rise in dollar terms if the dollar falls, even if their stock prices are relatively stagnant when measured in their local currency.
  • Many investors seek out growth from the investments they make. Right now, you can only find substantial economic growth by looking abroad to emerging-market powerhouses like China and Brazil.

Surprisingly, relatively few investors have jumped onto the foreign-investment bandwagon. Despite the stellar returns that many types of international investments have given investors lately, most investors still send only a limited amount of their assets abroad.

How to make a smart investment
Before you just jump headfirst into an international investment, though, you need to make sure you know what you're getting. All too often, you might find yourself with a portfolio that doesn't reflect your views on the global economy.

For instance, one simple way to invest abroad is to pick an index fund tied to the MSCI EAFE, a popular international stock index. The iShares MSCI EAFE ETF (NYSE: EFA  ) , for instance, has risen more than 50% in the past year.

Yet when you look more closely at the fund, you might be surprised to learn that despite its international scope, the fund concentrates most of its assets in just a few areas of the world. Companies in Japan and the U.K. make up nearly half of its portfolio, with top holdings including BP (NYSE: BP  ) , Vodafone (NYSE: VOD  ) , and Toyota (NYSE: TM  ) . 

Perhaps more alarmingly, eight of the top 10 countries represented in the ETF are in Europe, while you won't find a single emerging market represented in the fund. That's because emerging markets aren't included in the MSCI EAFE index. With all of Europe's recent problems, it might be the last place you want to put your money.

Pinning it down
That doesn't mean you can't get the exposure you're looking for. If emerging markets are important to you, then you can either choose a specialized emerging-market fund, or opt for a more broadly inclusive international index fund like Vanguard's Total International Stock Fund (VGTSX). Either one will add stocks such as CNOOC (NYSE: CEO  ) , Infosys (Nasdaq: INFY  ) , and America Movil (NYSE: AMX  ) to your holdings list.

In fact, with the broad array of investment options available, you can narrowly tailor your portfolio to include only the geographical areas or industries you want. You'll find country- and industry-specific ETFs for many parts of the world. It all depends on what you think is the best bet.

Broaden your horizons
Globalization is here to stay. What works for the business world can also work for your investments, and there's still time to beat the crowd by adding a greater international component to your portfolio. As long as your money is actually going where you want it to go, the right foreign investment can reap dividends for decades to come.

Everybody wants to travel, so why not let your money roam? Fool contributor Nathan Parmalee explains why you simply can't ignore these markets.

Fool contributor Dan Caplinger has the traveling bug, and it's not going away anytime soon. He doesn't own shares of the companies mentioned in this article. America Movil and CNOOC are Motley Fool Global Gains picks. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy follows you wherever you roam.


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