The conventional wisdom has long held that a well-diversified portfolio should include stocks from foreign countries. The rationale is two-fold. First, owning foreign stocks offers more exciting growth opportunities than investing exclusively in U.S. companies. After all, strong as the U.S. economy may be, it's still a relatively small fraction of the world economy. Second, owning foreign stocks has long been thought to provide a diversification benefit. Ideally, when the U.S. stock market zigs, your foreign stocks will zag, offering you more stability overall than a portfolio comprised solely of domestic stocks.

How have these arguments held up over time, and more importantly, what do their prospects look like for the future? Regarding the diversification benefit of foreign stocks, the jury is still out. Looking back over many years, there has indeed been a benefit to owning foreign stocks, in terms of absolute returns as well as dampening volatility. However, that effect has been muted over the past 15 years or so. In recent years, foreign stocks have risen and fallen much more in unison with our own market, diminishing their diversification benefit.

If the diversification aspect of owning foreign stocks is questionable at this point, what about the opportunity angle? On this point, there's certainly an interesting case to be made in favor of foreign investing. First though, a warning: experts have been predicting the demise of U.S. business at the hands of foreign competition for years, and it hasn't happened yet. But thinking it through, there's no question that America faces some significant challenges that our most likely challengers in the 21st century do not.

The Congressional Budget Office predicts that if our entitlement programs aren't reformed, the government's share of GDP will approach 50% by 2030. In addition, our health care costs are already high and moving higher, and we have the overhang of a zealous (some might argue out-of-control) tort system weighing on our business competitiveness. Contrast this to the economies of China, India, Taiwan, Singapore, and the other "Asian Tigers" where growth is higher than in the U.S., supplies of educated labor are deep and cheap, few health care benefits are provided, and the tort bar is virtually non-existent. Given those comparisons, it's not hard to argue that a considerable part of the market action over the coming decades is going to be outside our own shores. That's not to say we should stop investing domestically—American business certainly has a lot going for it, not the least of which is simply a head-start. But it seems wise to diversify abroad as well.

If that's true, and an investor wishes to invest internationally, there are three main groups of mutual funds to consider. Here at Sound Mind Investing, we include each group separately in our monthly Fund Performance Rankings, and it's worth noting the differences:

● Global funds normally allow their managers to invest anywhere in the world where they find attractive opportunities, including in the U.S. A global fund may own very few foreign stocks or may own an almost exclusively foreign portfolio. In Sound Mind Investing's model portfolios, we allocate a certain amount of money specifically to be invested internationally. Since we can't really count on a global fund to invest all of that allocated money abroad, we tend to shy away from these funds. We prefer funds where we know all the money is invested internationally—that way we're in control of our overall allocation decisions rather than leaving it in the hands of fund managers.

●  Foreign funds invest nearly exclusively outside the U.S., and will typically have no more than a few percent of their assets in U.S. stocks. It's up to the discretion of each individual fund whether to set any limits on how large a percentage of assets can be invested in any single country or region. But normally this group is the place to look if you're interested in investing across a number of countries and regions through a single fund. In our view, this is the ideal scenario, as it allows the foreign fund manager—who we're counting on to be the expert—the ability to move money around the world to whatever areas he/she thinks offer the most promising conditions.