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International Mutual Funds

One way to help diversify your investment portfolio is by purchasing shares in mutual funds that invest in companies based in countries outside the United States, or in multinational companies that do business around the world.

Although it's true that stock markets worldwide are increasingly responsive to similar economic events, the performances of individual markets in different countries mostly respond to the economic or political situations in their own countries. So even as those local markets rise or fall with general global trends, most also reflect their own local or geographical conditions.

By investing in more than one international market or region, you increase your portfolio diversification. This can be helpful when one market may be doing well, while the other is in a downturn. There's no guarantee that just because some of your funds are doing poorly, others are doing well, of course.

Currency Risk

When you invest in international markets, your return depends not only on how well the investments perform but also on the changing values of the currencies in the country where you live and in the countries where you are invested.

If the US dollar gains in value against the currency of the country where you're invested, what you earn in dividends or interest will be worth less than what those earnings are worth to residents of the country.

For example, when you use US dollars to buy a stock sold in euros, and the dollar gains in value against the euro, any dividends the stock pays will convert to fewer dollars because more than one euro is required to equal one dollar.

The good news, ironically, is that if the US dollar loses value, the value of your overseas investments can increase.

International Funds

International funds, also known as overseas funds, buy securities issued by non-US companies. Some international funds invest broadly, buying in both mature markets and faster growing emerging markets. Broad-based funds may include both large- and mid-cap companies in their portfolios in order to seek a combination of stability and growth. Or, you may prefer to invest in international funds that focus on more volatile small-cap companies. Let the prospectus be your guide in figuring out a fund's holdings.

Another strategy you could consider is to look for international index funds rather than actively managed funds. An international index fund buys a basket of stocks in a particular index in order to replicate the performance of the index. For example, several investment companies offer mutual funds indexed to the Morgan Stanley Capital International (MSCI) World Index or the Standard & Poor's (S&P) Global 1200. There are also index funds linked to regional indexes or those more specifically focused on individual countries or specific sectors of the economy.

In most cases, an international index fund has lower fees than an actively managed fund that invests in the same country.

Other Approaches to Index Fund Investing

World funds, also called global funds, invest in securities issued by companies in a variety of countries, including the United States. In fact, some world funds invest up to 75% of their assets in US companies. Bear in mind that if you want to add international exposure to a portfolio concentrated in US companies, a world fund may be too heavily invested in US stocks to do the job.

Regional funds focus their investments in countries within a single part of the world. A regional fund may be more volatile than an international or world fund because it's buying stock in a concentrated group of countries whose economies tend to be closely aligned. On the other hand, a regional fund is poised to benefit when the economies in which it invests are on an upswing, potentially even if other areas of the world are not doing so well.

A country fund buys securities that are issued in a single country. Typically, it's an established market, where enough potential investments exist to create a portfolio.

Mature vs. Emerging Markets

A mature, or developed, market is generally located in an industrialized country with a relatively long stock market history and substantial market volume. Mature markets also have documented trading methods, an established listing system, and an official and effective market oversight agency.

An emerging, or developing, market, in contrast, is generally located in a country with a relatively short stock market history, an evolving emphasis on economic stability and market oversight, and a growing list of public companies whose stocks are available for trading.

It will be good to remember that markets in these categories are not fixed. A market identified by one mutual fund company as mature may be classified as emerging by another. And a market that is emerging one year may be widely considered mature by the next.