Heed the Red Flag on China-Focused Funds

Investing in China as becoming almost as common as hand-wringing over whether the country will surpass the U.S. as an economic superpower.

It's easy to see why, with GDP growth of almost 10.5% last year and an expanding middle class. Mutual funds focusing on China have come along for the ride: The average China-focused mutual fund tracked by Morningstar has returned 18.2% in the first five months of the year and has three-year annualized returns of 29%.

But there are dangers in putting too much money to work in any single country, even one with an economy as strong as China's. (Just witness Monday's 8% slide in the Chinese market.) And the Chinese government's decision to triple the stamp duty on stock trades last week, which was designed to cool an overheated market, offers a timely occasion to re-examine investing in the region.

"The average investor shouldn't even be owning a China fund, let alone be worried about what it's been doing," says Morningstar analyst Bill Rocco. "The China story is so accessible ... but [people] don't think, 'Well, where does this fit into my portfolio?'"

Rather than putting money into a narrow fund concentrated on one emerging market, Rocco suggests that the average individual investor follow a strategy similar to their domestic holdings when investing internationally. Namely, large-cap funds and large market-oriented funds.