'Should I have foreign funds in my 401(k)?'

@Money June 8, 2012: 11:28 AM ET

(Money magazine) -- What percentage of my 401(k) and other investments should be invested in international funds? -- Adam Young, Chicago, Ill.

With all the problems Europe's been going through lately, including credit rating agency Fitch's downgrade of Spain's debt to near-junk status, I'm sure many people would say the answer is zero.

But it's a mistake to base any investing decision solely on the news of the moment. After all, it was just 10 months ago that many investors began fleeing U.S. stocks after Standard & Poor's downgraded U.S. Treasury debt from AAA to AA+. But those who did likely regretted the decision, as U.S. stocks have gained roughly 10% since then.

While much international financial news is scary these days, no one really knows how foreign stocks will perform versus U.S. shares in the years ahead.

That uncertainty is one of the two reasons to diversify internationally in the first place. You want to hedge your bets rather than put all your dough in any single market.

The other reason is that by adding some foreign funds to an all-U.S. portfolio, you can actually lower the volatility of your portfolio without sacrificing return over the long-term.

When it comes to investing in foreign funds the real issues are: how much exposure to international markets do you need in order to reap that risk-reducing diversification benefit? And what's the best way to get it?

Many advisers these days recommend putting 40% or more of the stock portion of your portfolio into foreign funds. Frankly, I think that's a bit much.

A study last year by Vanguard shows that you get virtually the same diversification bang for your buck at a 30% allocation as 40%.

And recent research by Wealthcare Capital Management CEO Dave Loeper -- one of the rare independent thinkers in the investment world -- suggests that 10% to 20% is sufficient. He typically uses 15% in the portfolios the company creates for its clients.

So while I'm sure one can make a case for a higher or lower percentage, investing anywhere from 15% to 20% of your stock stake in foreign shares strikes me as reasonable.

As for how to get that foreign exposure, I think the easiest and most effective way is to invest in a total international stock index fund or ETF, both of which are available on our MONEY 70 list of recommended funds. In a single fund, you'll get the entire global stock market outside the U.S. -- Europe, Asia, all the developed countries, emerging markets, the whole shebang.

What's more, since such funds invest their money based on the percentage of total foreign stock values each country represents, trouble spots like Spain and Greece account for only a tiny portion of fund assets, 1.6% and 0.1% respectively. Which means if you've got 20% of your assets in a total international stock fund, you effectively have just 0.32% of your money in Spain and Greece combined, or less than a third of a percent.

That's not to say that woes in these or other countries might not trigger major upheavals in markets both here and abroad. In today's highly connected economies and financial markets, problems in almost any country can cause ripples (if not tsunamis) in other parts of the world.

But the fact that you never know where trouble might start or where it will cause the most damage is all the more reason to diversify broadly around the globe.

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