International mutual funds, which invest their money outside the U.S., can be useful tools for diversifying your portfolio. You're able to tap into a pool of opportunities that, as of the end of 2012, were more than twice the size of what the U.S. offers. You'll also be able to take advantage of the higher rates of growth in some parts of the world. Dividend-paying funds reduce some of the risks of international investing.
Foreign Income Funds
A dividend-paying international fund lets you enjoy regular cash flow while exposing you to world markets. Dividend mutual funds, also called income funds, buy stocks that return some of their cash earnings to their shareholders and pass those gains through to you. Growth funds, on the other hand, invest in companies that use their cash to fund their growth, paying few, if any dividends.
One of the drawbacks of investing in international funds is that their expense ratios tend to be higher than those of other equity funds. Based on the Investment Company Institute's 2013 Fact Book, the median expense ratio for an international fund is 1.47 percent. That would cost you $14.70 for each $1,000 you invest. The overall median for equity funds is 1.33 percent, and the median for income funds is 1.12 percent. You would typically pay $13.30 and $11.20 per $1,000 invested in each of those fund types, respectively. For example, if a $100,000 investment had an 8.1 percent return before the expense ratio, it would turn into $108,100 after a year. After expenses, the same investment in an international fund would generally turn into $106,630. An investment in the typical equity fund with the same return before expenses would become $106,770 after the lower expense ratio. A domestic income fund would become $106,980.
International funds tend to be more volatile than domestic ones. While some economies are more stable and have steadier financial markets, others, like those in emerging markets, bounce around more. Because of this, having all of your earnings come in the form of increasing net asset values, which also seesaw, can make your investments more prone to wide price swings. Having a dividend-paying fund helps reduce this risk because some of your returns are coming in cash, which is inherently less volatile.
An international mutual fund is really an investment in two different sectors. You're not only buying stocks but also indirectly purchasing the currencies of the countries where those investments are located. If a country's currency drops in value, the relative value of shares held in that currency will also sink, simply because you'll get fewer U.S. dollars for the shares when you sell them. When you earn dividends from these companies, though, they are converted back to U.S. dollars. Therefore, while your returns are subject to change before you get paid, they stop fluctuating when you receive them.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.