Three Myths of International Investing

Like any other field, international investing has its conventional wisdom. Listed below are three accepted principles that we hear often from readers and reporters. Like many conventions, these notions do contain kernels of truth. If you let them exert too much influence on your investing habits, however, they can lead you astray.

The good news is that discarding these ideas can make thinking about international investing much simpler. With flows into foreign funds on the rise, it seems appropriate to examine three specific claims.

Myth No. 1: If the dollar is weakening, it's a good time to invest in foreign funds.
Not necessarily. To be sure, this much is true: When a U.S.-based investor owns a foreign-stock fund and the dollar loses value against foreign currencies, the investor's returns are higher than they would otherwise be. (Unless the fund is fully hedged into the dollar, which is rare.) That's because the fund owns stocks denominated in those strengthening foreign currencies. So a 5% gain in the stocks might become a 15% gain for the U.S. investor, let's say, when the currency gain is factored in.

So far, so good. But several things can spoil the party. For instance, you can still lose money even with the currency movement going your way if the foreign markets in question--or the fund's specific picks--struggle. Let's say that instead of gaining 5% on its stock holdings, the above fund loses 20% on them. After currency gains are factored in, a U.S. shareholder still suffers a 10% loss. That's exactly what happened in 2002, when plunging stock markets meant heavy losses for U.S.-based shareholders of most foreign funds even though the dollar weakened and foreign currencies rose.

That brings up a related concern: A falling dollar can hurt foreign companies and thus send their stock prices down. In particular, those that export to the U.S. find their goods effectively becoming more expensive versus those from American companies. That's not good for business. Another sticking point: The theory assumes that a falling dollar will keep falling. Will it? If so, for how long? Currency movements have a habit of surprising even the experts who spend all their time studying them.

But cheer up! All of this means you can safely ignore currency factors when making long-term investment decisions.

Myth No. 2: Choosing a foreign fund is more complicated than choosing a domestic fund.
Not really. When searching for a foreign fund, you should look for strong relative performance over time, reasonable expenses, an experienced manager who sticks to an understandable strategy, and an approach that fits your personal preferences. Those are exactly the same traits you look for when picking a domestic fund.

Of course, some differences do arise. If you are particularly skittish about emerging markets or Japan or another area, you'd want to check out a fund's country and region weightings. But even that typically isn't worth the effort. Who knows which region will outperform over the long term? And even if you do know, it may not pay to choose a fund on that basis. A talented manager can find gems even in lagging markets.

Currency exposure is another difference between foreign and domestic funds. However, as noted above, a fund's currency-hedging approach, while worth knowing, does not need to play a large role in your selection process.

Myth No. 3: If your overall foreign stake rises or falls below your targeted allocation figure, you should quickly rebalance.
We often recommend looking at your portfolio and reallocating money from time to time so, for example, you don't get overexposed to hot areas that are about to cool off. So why shouldn't you do that with your foreign exposure? Well, you can, but there's no need to overreact.

That's because in addition to being "foreign," a stock is also a specific company in a specific sector. Therefore, if you own just a few funds and one of your domestic-fund managers decides to make a play on cellular-phone makers or semiconductors or pharmaceutical firms, you might find your "foreign" exposure increasing as a result, but not because the manager is betting on foreign markets: At that moment he or she just happens to prefer companies in fields that are based overseas.

With so many global leaders in those sectors headquartered abroad--Samsung,  Nokia (NOK), and  GlaxoSmithKline (GSK) are only three examples--such a scenario easily could occur. If it does, it wouldn't make sense to become alarmed and cut back on your dedicated foreign small-cap fund, say, just to keep your overall international allocation within a specific range. So there's one more concern off your mind.

Of course, not all conventional wisdom should be discarded. In some cases, it can help simplify and improve your investing life. But when it does neither, feel free to toss it aside.