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Diversify College Savings With Foreign Mutual Funds

Foreign mutual funds that invest in developing nations could be risky – but could bring bigger rewards.

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Investments within the tax-advantaged college savings accounts known as 529 plans should have as much variety as investments in 401(k)s, experts say. One way to do this is to mix in foreign mutual funds to help save for college.

Foreign mutual funds often have higher fees than other investments, but provide plan owners a level of protection from the ups and downs of the U.S. stock market. A foreign stock market could do better at times than a U.S. market.

Investment advisors recommend parents allocate some 529 plan savings to foreign mutual funds as a way to diversify the plan's portfolio. Parents should make sure to avoid investing all college savings in one mutual fund, because if the value decreases, all their money is at risk.

[Get advice and information about how to pay for college.]

More than half of the world's largest companies are located outside of the U.S., says Lisa Featherngill, a certified public accountant and certified financial planner in North Carolina. Families who don't invest in foreign mutual funds could be missing out on a lot of chances to diversify their mutual funds.

But diversification goes beyond choosing mutual funds containing large companies. Families can also diversify by picking mutual funds containing stocks in businesses in developing countries like India or emerging markets such as China.

Emerging markets, where the economy is still developing, are higher risk but can lead to higher profits. Investments in these markets are best left to families with children who are younger, as they have time to recover if mutual fund prices plummet, says Susan Howe.

The Pennsylvania-based certified public accountant says that emerging market investments wouldn't make sense for a 16- or 17-year-old student, who will need college funds relatively soon. Parents of these students should stick to foreign mutual funds with investments in blue-chip stocks, larger companies in developed countries.

[Learn how to choose an age-based 529 plan.]

"An investment in a rare mineral extraction company in an African country might seem like it has big potential for high returns," she says. "And it may, unless the government destabilizes, or the company turns out to be poorly managed, or the local currency dramatically rises or falls. If that money is needed within a couple of years, there may not be time to recover any losses suffered in that situation."

These kinds of complications highlight the importance of checking on a fund's management. Parents should ask the 529 plan manager about how a fund is managed, experts say.

"Parents need to choose funds that are managed well, which often means higher fees," Howe says. The higher fees are warranted if the manager is "more knowledgeable about global economies and the risks of investing in foreign companies," she says.

[Find out how to select mutual funds for your 529 plan.]

A mutual fund manager choosing investments in foreign companies needs to understand traditional financial health measures of companies, in addition to the politics and policies of individual countries, including financial reporting practices, Howe says.

It's also important that 529 plan managers or advisors can explain to parents why the higher fees are worth it for each particular fund and management team, experts say.

"I would recommend funds that are U.S.A.-managed, rather than one that is more fully internationally managed," says California-based certified public accountant Daniel Morris. In his experience, U.S.-managed funds are more stable investments.

He also says to "stay with larger, public-style funds rather than private-style equity funds – that might require more reporting" of financial details.

Though foreign mutual funds shouldn't be the only investments in a 529 plan, investing part of the money in these funds makes sense, says Morris. "Look at the portfolios holistically."

Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.