Foreign-Stock Funds and the Benefits of International Diversification

In 2007, mutual funds specializing in non-U.S. stocks returned a fat 16%, while funds with diversified holdings in U.S. equities returned just over 6%. In fact, the foreign-stock funds have beaten domestic-stock funds over periods of two, three, five, 10 and 15 years, according to Lipper, the fund-tracking company.

On top of that, owning foreign stocks helps a U.S. investor diversify risk by reducing a portfolio's volatility , thus improving compounding over the long term.

Why is it, then, that so many surveys show that the typical U.S. investor does little more than dabble in foreign stocks? The average small-investor portfolio has 10% to 12% of its equity investments committed to foreign stocks, while many experts recommend 20% to 40%. "People tend to invest more in their local stocks," says Wharton finance professor Karen K. Lewis, adding, "There are big gains from diversification that people don't exploit." ...