Hey, what’s going on out there?

In January, stocks all over the world tumbled – led by the whopping 7 percent decline in Japan.

That’s obviously bad news for investors overseas, but should Americans care?

Yes, for lots of reasons.

Most importantly: Many Americans own foreign stocks, either directly or through mutual funds.

Lipper Inc., the fund-tracking company, says, for example, that as of Dec. 31, U.S. mutual funds that owned foreign stocks had nearly $900 billion in holdings – about 20 percent of all stock-fund assets.

Secondly, stock markets that were once isolated in individual countries are now interconnected – so what happens to one can affect another half a world away.

Part of the explanation is the globalization of all kinds of markets – many companies based in one country do business in others.

Also, fast communication and computers make it easy for investors in London or New York to react to news affecting markets in Tokyo, Seoul or Beijing. So U.S. stocks sometimes move up or down in sympathy with foreign ones.

It’s become easy for investors to play in foreign markets through mutual funds, exchange-traded funds, American Depositary Receipts – a kind of stand-in for a foreign stock on a U.S. exchange – and through options and other derivatives based on things such as currency and interest-rate movements.

While the fortunes of a lone foreign stock shouldn’t affect people who don’t own it, investors can be emotional. So it doesn’t seem surprising that Japanese investors would react badly to news that a hot Internet company in Japan, Livedoor, may have padded its results.

Also, Japanese stocks rose about 40 percent last year, so there must be many investors who prefer locking in profits by selling to waiting around for the scandal to unfold. Livedoor just gave them an excuse.

But why would investors in other countries start bailing out of stocks that have nothing to do with Japan?

Because jitters are infectious, and an investor whose Japanese holdings take a dive might turn conservative and dump some U.S. or British holdings he sees as too risky. Even the most level-headed investor is prone to worry that share prices around the world would fall if all the dummies out there start selling. Sometimes the option is to run with the mob or get trampled.

Small investors, then, should take recent events as an object lesson: owning foreign stocks involves all the risks of owning American ones, and then some.

There’s the risk of unexpected events, as in the Livedoor case. There’s the risk of broad panic or bursting bubbles.

On top of that, in many foreign markets, accounting and corporate-reporting rules may be more lax than ours. There may be corruption, political instability, war …

And there’s the endless shifting of currency exchange rates. It’s common for a winning investment to turn into a loser when foreign money is turned into dollars.

None of this means Americans should shun foreign stocks.

On the contrary, Standard & Poor’s investment newsletter, The Outlook, recommended that Americans keep 20 percent of their investment portfolios in foreign stocks, along with 45 percent in U.S. stocks, 20 percent in bonds and 15 percent in cash. Its foreign-stock recommendation is pretty typical.

But because of the many added difficulties of assessing foreign stocks, small investors should buy them through U.S.-based mutual funds, many of which have done quite well.

Lipper’s year-end figures, for instance, show that the average foreign stock fund returned nearly 18 percent in 2005 compared with 6.7 percent for the average diversified U.S. stock fund.

The standouts were Latin American funds, up 53.4 percent, Japanese funds, up 33.6 percent, and emerging-markets funds, which invest in less developed countries and were up 31.9 percent.

Over longer periods, foreign stock funds aren’t likely to outshine U.S. ones by as much as they did last year – foreign funds returned an annual average of 7.6 percent over the past decade, vs. 8.6 percent for the diversified U.S. funds, for example.

But there is something to be said for the view that many foreign economies have a lot more room to grow than the U.S. economy does. If so, there could be some terrific opportunities to get in on the ground floor.

Hunt for foreign stock funds on the Web site of Morningstar, the fund-tracking company, at www.morningstar.com.

Also, pick up a copy of “The Future for Investors” by Wharton finance Professor Jeremy J. Siegel. He argues that many foreign markets will continue to offer good returns, but he warns against jumping into ones that already have delivered stupendous gains.

Jeff Brown is a business columnist for The Philadelphia Inquirer. E-mail him at [email protected]


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