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Thursday, 19 June 2008

Missing the boat on international funds

If your adviser is only now recommending you move some of your portfolio into global stocks, it might be time for a new adviser. Watch out for these red flags.

NEW YORK (Money) -- Question: I read your recent article in Money magazine regarding the craze for international investing. This past week my adviser has recommended this move since I have very little money in the international market. She recommended Nationwide International Growth Fund (GIGAX) and the Ivy Asset Strategy Fund (WASAX). What do you think of her advice?

The Mole's Answer: Boy, are the red flags waving. I see at least three warning signs that it's time to start looking for a new adviser.

Red Flag #1 - Previous lack of international stocks

I would first start by asking your adviser why you currently have so little money in the international stock market. We've been a global economy for many years and I'd want to know why your adviser thought putting all of your eggs in a basket of U.S. stocks was the right thing.

When your adviser picks which asset classes she thinks will outperform others, all she is doing is creating unnecessary risk for you. She apparently bet on U.S. stocks which, between 2003 and 2007, earned a nice 82% return. Unfortunately, international stocks more than doubled that return at 168%. In other words, it may have been your adviser's bet to put little of your portfolio in international stocks, but you're the one it ended up costing.

Red Flag #2 - Classic signs of performance chasing

A good adviser can help provide some focus and discipline to your portfolio. Part of that discipline should be to stop you from chasing what's hot. A recent study showed that advisers as a whole performance chase about as much as individuals. That's because it's easier to sell something that's hot than something that's not.

The fact that your adviser is suggesting you get into international stocks after such hot performance, and after underweighting you in international stocks for so long, looks like a sure sign of performance chasing to me. And performance chasing has you taking the old buy high/sell low path that I would avoid like the plague.

Red Flag #3 - Funds that generate high fees

Both funds your adviser recommended have front-end loads that charge as much as 5.75% of your investment the minute you buy the funds. So you start with only 94.25% of the amount you originally invest. Further, their annual fees range from 1.13% for the IVY fund, and 1.57% for the Nationwide fund, according to Morningstar. Fees like those make me cringe.

Plus, both of these funds happen to have turnover well above 100% annually. This means they hold a typical stock for less than a year. The high turnover does two things:

* It creates additional hidden expenses from trading stocks frequently.
* It creates taxes from any gains - and at the highest short-term rates.

Now if your adviser is reading this, she is probably steaming mad and saying to herself that these two funds actually have very high Morningstar ratings and have whomped their peers. While she is absolutely right, that is yet another indication of performance chasing.

Any adviser can screen for the funds that pay us commissions and have performed well in the past. With thousands of mutual funds out there, it's nearly a mathematical certainty that some expensive funds will do well. Some advisers will seek out these funds and sell them to clients, even though the data is compelling that the odds of the stellar performance continuing are quite low.

My advice: Ask your adviser why now is the right time to go from virtually no international stocks to dramatically increasing your allocation. As uncomfortable as it might be, ask her if it is performance chasing that is driving her recommendation. Finally, ask if there are lower fee vehicles that can be used to build your portfolio.

International investing is a critical component of most portfolios, but owning a consistent proportion is far more critical than moving in and out. Performance comes and goes but fees are forever, so do all of your investing with low-cost and broadly-diversified vehicles. And that holds true whether you use an adviser or do it yourself.

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