Stock mutual fund investors made money for a third straight year in 2005. And once again, Americans scored the biggest gains by sending their cash abroad.
Funds that invest overseas trounced domestic funds for a fourth year. The average foreign stock fund produced a total return of 17.4% for the year, compared with a 6.7% return for the average U.S. fund, according to Morningstar Inc.
For many Americans, the percentage of assets held overseas has become the deciding factor between mediocre and spectacular investment returns in this decade.
And that is causing financial advisors to rethink classic guidelines about the proper mix of domestic and foreign shares in clients' portfolios. Some say it isn't outlandish to keep as much as 50% of an investor's total equity assets in overseas funds -- far more than the 15% to 20% that was considered prudent in the 1980s and 1990s.
If they're using the old rules, "I think most people are underinvested in foreign markets," said Russ Kinnel, director of fund research at Morningstar in Chicago.
Scott Leonard, head of investment advisory firm Leonard Wealth Management in Redondo Beach, said he has split the typical client's portfolio about 50-50 between U.S. and foreign shares since 1994.
"Americans look at foreign stocks as something ultimately more risky and dangerous than U.S. stocks. I just don't buy that," Leonard said.
Still, many veteran investors may remember foreign markets' miserable stretch from 1995 through 2001, when U.S. shares beat foreign issues every year but one. That period encompassed the downward spirals of Japan's economy and stock market, and some dramatic crashes in so-called emerging markets, including Mexico in 1995 and South Asia in 1997-98.
The struggles of many foreign markets in the 1990s may have fueled a kind of "misplaced nationalism" on the part of U.S. investors, Kinnel said.
But in this decade, nationalistic U.S. investing tendencies have been melting away in the face of some huge shifts in the global landscape.
One, of course, is the stunning rise of China's economy, which has triggered boom times across much of Asia and lifted commodity prices worldwide, benefiting emerging economies that are exporters of raw materials.
Another is the U.S. dollar's steep slide since 2002 against the euro, the Canadian dollar and many other currencies.
Some on Wall Street believe the dollar has been devalued because of the huge U.S. trade and budget deficits, which have in effect led to a glut of dollars around the world. Others say the currency became overvalued in the 1990s and that the decline in recent years was merely correcting some of that overvaluation.
Whatever the cause, the weaker dollar has given Americans another good reason to own foreign stocks: As other currencies appreciate, U.S. investors' holdings of foreign assets are worth more when translated into dollars.
A case in point: Mexico's stock market rocketed 37.8% in pesos last year. But because the peso also appreciated against the dollar, the market's total gain for a U.S. investor was 44.5%.
That helped to put Latin American stock mutual funds in the top spot among 34 major equity fund categories tracked by Morningstar. The average Latin American fund soared 53.8% in 2005.
But the dollar can cut both ways. In 2005, the buck surprised many on Wall Street by recouping some of its 2002-04 losses against the euro and the yen. That hurt U.S. investors' returns in European and Japanese stocks. The German stock market, for example, was up 27.1% in euros, but in dollars the gain was reduced to 11.1%.
Even so, the average European stock mutual fund gained 14% last year, more than twice the return of the average U.S. stock fund.
And so far this year, foreign markets again have a tailwind from a weaker dollar: A Bloomberg index of 500 European blue-chip shares is up 2.7% in euros and 4.8% in dollars, outpacing the 3.4% gain in the U.S. Standard & Poor's 500 index.
Despite the fear U.S. investors may have that hot foreign markets are getting ahead of themselves, Wall Street generally can find more reasons to be optimistic than pessimistic about overseas economies and stocks:
* Unlike in the U.S., where some economists worry that overextended consumers may be cutting back on spending, the sense is that consumption is poised to increase overseas.
"Evidence is mounting that the U.S. economy is slowing while other economies, especially those of Japan and Europe, continue to improve," said Joseph Carson, economist at Alliance Capital Management in New York.
* In Western Europe, "many governments are turning to tax cutting, in part to get their moribund economies moving, but more to compete with the new Eastern European members of the European Union," said Milton Ezrati, senior economic strategist at fund giant Lord, Abbett & Co. in Jersey City, N.J.