How China's Economy Affects Your Investments

You aren't a currency trader. You don't play in Shanghai's boom-and-bust stock market. (It was only beginning to open to investors when the crash hit.) But if you have some money in a 401(k) or an IRA, you have a stake in the news coming out of China, even if you hardly think of yourself as a global investor.

The China bet in your mutual funds. If your portfolio includes an international-stock fund, it likely holds some Chinese companies that list shares on the Hong Kong or New York exchanges. For example, Vanguard Total International Stock Index Fund, the biggest foreign-stock fund, holds a bit less than 5% of its assets in China. At least as important are such funds' holdings in countries like Brazil that sell a lot of raw materials. As China's resource-hungry manufacturing economy slows, "the No. 1 thing getting shellacked is commodities," says Robert Johnson, director of economic analysis at Morningstar. That has hurt commodity-producing countries.

Ripple effects close to home. A significant chunk of U.S. investments are closely linked to China. About 10% of the S&P 500—the benchmark followed by most fund managers—is in energy or basic-materials stocks, and those are down sharply this year.

More broadly, China's surprise move to devalue its currency "reinforced the perspective that all is not well in the Chinese economy," says Harry Hartford, president of Causeway Capital Management. China may be slowing even faster than investors thought. American multinationals hoping to sell to a rising Chinese consumer, particularly automakers, report that sales are slipping.

The smart move: stay diversified. As big as the events in China may feel right now, that doesn't mean you have to act. "There's very little evidence that individual investors are great at timing stocks," says Research Affiliates chief investment officer Chris Brightman. (Don't feel bad: pros have a lousy record too.)

If you are tempted to bail out of an international fund right now, bear in mind that U.S. stocks are hardly a haven. Looking at prices compared with the past 10 years of earnings, the stocks on the S&P 500 are relatively expensive. On the one hand, bad news about China might be the thing that breaks the bull market's so-far optimistic psychology. Or maybe the market decides that slower global growth will continue to hold down interest rates, which could support high equity valuations for a while longer.

Instead of trying to guess, make sure you have a portfolio that can handle shocks. Hold many different kinds of stocks, along with enough in bonds and cash to get you through the bad years. China just shows that the markets are full of surprising risks--and they can come at you from the other side of the globe.

Why Trouble in China is Hitting Your 401(k)

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