January 19, 2010 - China is all the rage. It has a booming economy. Many investors are intrigued by it. Some already own stocks in China. But is it a good time to buy into the Chinese dragon, especially if you are new to foreign investing? Let's look at another point in history, at another hot country and see how that turned out.

With its new found wealth, Japanese investors looked abroad while American investors looked to Japan, hoping to catch some of the new wealth. Japanese real estate was climbing faster than any U.S. dirt. Books were written about how smart the Japanese were, how the U.S. had lost its frontrunner position, how the Japanese were superior at handling problems like unemployment, inflation and government deficits. There was an inevitability about the new economic world: Japan would take over everything, not by force, but simply by buying it.

The popular reasoning for U.S. investors was to buy Japanese stocks and sell American ones. That was where the smart money was going.

Let's take a look at how that turned out. Initially, some investors made money. But the Japanese equity market hit its height in 1989. From that point forward, it was all downhill. Since then, Japanese stocks are down 73% while U.S. stocks are up 219%. The Japanese economy grew at an annual rate of 1% a year while the U.S. economy showed 2.5% improvement annually. Clearly, the most money was made from U.S. equities compared to Japanese equities.

The spectre that loomed largest at the time was that Japan with its surplus trade account could buy anything it wanted. And it bought a lot of U.S. real estate, even Pebble Beach and the mighty Arco building in Los Angeles. The fear was that Japan would soon become America's largest landholder. From there, the imaginations went wild. But nothing untoward happened. In fact, most of the Japanese investors bought real estate at its highest valuation and very few if any sold their holdings at a profit. The U.S. didn't change its way of doing business. The government didn't collapse. In fact, prosperity came roaring back in the '90's, and Americans enjoyed one of the most prosperous economies ever. We learned there was a little too much prosperity, some of which was all smoke and mirrors, for which we are now paying. But that's another story.

Now we look at China. It's basically in the same position Japan was in the late '70's. It has a booming economy. It looks like it has a handle on unemployment, government deficits, inflation. Maybe it does. But its growth won't be smooth and straight up. No country's ever is. There will be periods of unemployment, inflation and deficits in China. Investors just don't know when. The further along the Chinese economy booms, the closer it gets to one of the inevitable busts. Just like we survived in the U.S. recently.

So investing in China may be good for a while but it's not the kind of investment that warrants a full fledged commitment. And buying individual stocks is best left to the pros who live there or have extensive research capabilities. For individuals, a Chinese mutual fund is a great way to invest. Some of the better performing ones, according to Zack's Investment Research, have been: Dreyfus Greater China A (DPCAX) which aims for long-term capital appreciation; AIM China A (AACFX) which also seeks long-term capital growth; and Old Mutual Clay Finlay China A (OMNAX) another fund dedicated to long-term capital growth. More research can be found on AOL in the Personal Finance section or at Web sites such as Zach's or Morningstar or MarketWatch.

China has a siren call for many investors who see unlimited potential, huge markets, and a growing economy. But keep the Japanese experience in mind. Nothing grows to the sky, and while the U.S. is currently mired in many problems, it has proven over and over again that it has the resources, mental and physical, to bounce back. Sometimes very quickly.

- Ted Allrich