The Good, Bad and Ugly of International Mutual Funds

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Investors looking to add some global sizzle to their portfolios without having to pack a passport often turn to mutual funds to gain international exposure. It's happening in a major way these days. Investors may have poured a net $35 billion into domestic stock funds last year, but that's nothing compared to the net $228 million put to into play in international funds according to industry tracker Investment Company Institute.

Should you follow the herd overseas? The rewards could be substantial, but the same can also be said about the risks. Let's go over some of the things to keep in mind before going global with your portfolio.

The Good

The chief arguments in favor of mutual funds in general -- instant diversification with a single investment, seasoned money management calling the shots and reasonable liquidity -- also apply to international stock funds.

Another major advantage is that investors don't often have easy access to researching and buying overseas companies. There are plenty of foreign companies that trade on stateside exchanges, but international funds often go directly to the underlying markets to buy from a wider pool of stocks. Paying for professional money managers who devote their time to researching international stocks is also a strong selling point for stateside investors, even those who prefer to pick domestic stocks on their own.

The Bad

There is a price to pay for proven money management, and that comes in higher fees than typical mutual funds. Investors in international stock funds faced an average expense ratio of 1.47 percent in 2013, according to premium research provider Morningstar (MORN). That's quite a bit more than the 1.25 percent average being shelled out by investors in U.S. equity funds. That may not seem like a big difference: We're talking about $22 a year in management expenses for every $10,000 invested. However, it does add up over time.

The Ugly

The pursuit for exotic returns also often comes with exotic risks. Investors learned that the hard way when the strong dollar ate into the returns of funds buying into overseas stock markets. The euro crisis and setbacks in Asia also stung results. The average large-cap international fund surrendered 4.8 percent of its value. That doesn't stack up very favorably to the S&P 500's (^GSPC) better than 13 percent return.

There's also great volatility for international investors, particularly for those buying into country-specific funds. One of last year's hottest regions for investors was India, but India-focused stock funds were the worst performers during the most recent quarter.

Since many international funds don't actually hedge against currency risk, it's often a wild ride.

So, yes, there are some legitimate advantages to buying into international mutual funds. You get seasoned management that researches foreign equities for a living. That's valuable, but with few exceptions that exposure also carries greater risks.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. Check out our free report on one great stock to buy for 2015 and beyond.
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