A China bull

Question: I would like to consider putting a small portion of my retirement (and/or other) investment money in Chinese stocks. Is this a reasonable thing to do and, if so, can you recommend some funds, or a place to investigate potential funds? Thanks, Lyle, Big Horn, WY

Answer: China is fascinating. There are a number of compelling reasons why investors are intrigued with Asian giant, the world's largest developing nation. Its emergence is reminiscent of the U.S. in the years after the Civil War when America's industrial output lagged far behind that of Germany, France, and Britain. Yet from 1870 to 1914, America's economy expanded fivefold and the U.S. became the world's leading industrial power. "I'll go a step further," writes Jim Rogers, the well-known investor and China bull, "just as the nineteenth century belonged to England and the twentieth century to America, so the twenty-first century will be China's turn to set the agenda and rule the roost." (Rogers believes so strongly in China's future that when I talked to him last year he had moved his family to Singapore, joining the giant--and still growing--community of investors and business folks putting down stakes in the Chinese Diaspora. He wants his children to grow up knowing Asia and Chinese.)

China is a great long-term growth story. More immediately, its economy has been expanding. But there are plenty of reasons to worry, from widespread corruption to an aging population to rural unemployment. For instance, the Chinese government unleashed an investment tsunami to offset the downward forces of the Great Global Recession. The strategy worked, but now the combination of a rickety banking system and lots of empty new office buildings is worrisome. The Chinese banking authorities are aware of the issue. They're trying to dampen the lending enthusiasm of its financial institutions. But it's a tricky maneuver to pull off.

Fact is, China has probably attracted too much capital in recent years. That's why it isn't hard to find experts who believe China's long boom will go bust despite the enthusiasm in many parts of Wall Street and Washington that the 21st century belongs to China. The belief in China's bright future and fear of economic turmoil isn't contradictory. After all, the U.S. economy may have expanded rapidly from 1870 to 1914, but along the way there were several depressions and financial panics (including the longest depression in U.S. history).

The bottom line: Investing in China isn't for the faint of heart.

That said, I certainly don't want to discourage you from putting a portion of your portfolio into China. I just wouldn't put your retirement savings at risk to your investing acumen. Instead, why not play with a small sum of money in a taxable account? This way if you end up being right you'll pay a low long-term capital gains rate when you cash in your chips. If you're wrong you'll share the loss with Uncle Sam.

There is no shortage of resources on investing in China. But among some specific avenues to investigate are exchange traded funds (ETF). The largest China ETF is the iShares FTSE/Xinhua China 25 Index. A handful of mutual funds focus on China, with the best known the Matthews China fund. You can learn more about mutual funds and China at Morningstar.com. And if you want to play in individual stocks there are quite a few that trade on the major U.S. exchanges as American depositary receipts or ADRs.

One last point: I'd think about investing in emerging markets in general rather than just China. Imagine, in 1800 Brazil, Russia, India and China (the so-called BRICs) made up more than 50% of world gross domestic product, according to economists at Goldman Sachs. (The figure largely reflects the dynamic economies of China and India.) These economies are expanding their share of world production. But it isn't just the BRICs. Vietnam, Malaysia, and Indonesia are embracing growth. So is Chile. Investing in a broad basket of emerging market economies is essentially a play on a rising middle class throughout the developed world.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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