A sensible foreign stock mix

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NEW YORK (Money Magazine) -- Question: If foreign stock funds are outperforming U.S. funds, why is it so commonly recommended to have 40 percent of your portfolio in U.S. large-caps and only 20 percent in international stocks? - Yolanda Holler-Managan, Akron, Ohio

Answer: Since Americans still invest a mere 13 percent of their money internationally - like people everywhere, we're uncomfortable investing far from home - in part the foreign-stock bar is so low for the same reason that your doctor tells you to take brisk walks and not to run 10Ks five times weekly: If taking advice requires too radical a behavior change, people will just ignore it.

But you're on the right track, though with the wrong rationale. Yes, foreign funds have beaten the U.S. market of late, but that hasn't always been true (nor can you bet it will stay true).

Chasing performance - moving money in and out of an asset class based on recent returns - always turns out badly.

The better motivation is diversification: Since more than half the world's stocks are outside the U.S., spreading your money worldwide will reduce your risk and give you a way to invest in global growth. And you'll guard against a weakening dollar.

But it takes a lot of inner strength not to buckle in years when foreign markets tumble (emerging markets are particularly prone to this) and the U.S. zooms.

Jim Peterson of the Schwab Center for Financial Research suggests putting 25 percent to 30 percent of your stocks overseas and diversifying further by splitting a third of that between small-caps and emerging markets.

Question: I know the residential housing market is way down, but does this affect the commercial market? I am thinking about investing in publicly traded real estate investment trusts. Is this a wise choice? - William Bernardi, Summerfield, Fla.

Answer: What's the effect of the housing meltdown on real estate investment trusts? Depends on the type of REIT.

The most common is the equity REIT, which owns and operates commercial properties, typically office buildings, shopping centers, hotels and/or apartment complexes.

Though struggling lately - their total return for the year was -13 percent as of late November - they're not tied directly to housing, says Morningstar REIT analyst Jeremy Glaser.

The risks the residential market poses for commercial REITs are indirect (and thus the same as those faced by other businesses): If housing pulls the economy into a recession, malls and office buildings will lose tenants.

Unlike the residential market, commercial real estate doesn't appear overbuilt, but the tougher borrowing standards that are crimping housing growth seem to be starting to squeeze the commercial market too.

That said, the big trouble today is among mortgage REITs, which don't operate properties but instead hold mortgages, either residential or commercial.

The sector's total return is -46 percent for the year as investors bail out of anything with even the vaguest connection to the subprime crisis. (See editor's note at bottom.)

In the long run, Answer Guy assumes, they'll recover. But for now it's tough to say whether mortgage REITs are near their bottom or have more room to fall.

Looking for some answers? Send us your questions about investing. E-mail answer_guy@moneymail.com.

Editor's note: An earlier version of the story incorrectly stated that the total yearly return for equity REITS was 13 percent, and that mortgage REITS returned 46 percent. They returned -13 percent and -46 percent respectively.