Currency Investing and Protection in your Portfolio – Do it the Smart Way

August 26, 2008 by  
Filed under Investing, Retirement Planning

The Decline of the Dollar Can Weigh Down your Retirement Portfolio

This post is for investors, including those planning for retirement, who want to allocate part of their portfolio to provide protection (or take advantage of) positive trends of foreign currencies against the dollar.
It seems that ever since the Euro achieved its now lofty status as a trading currency, the dollar has been in a steady decline against it.  That trend has stabilized in recent weeks but Mr. ToughMoneyLove is not optimistic that it will stay that way.

The hard truth is that many experts believe that the overall trend of the dollar against many foreign currencies will continue to be a negative one.  Therefore, the wise investor will want to factor in this risk in his or her long term portfolio.  In other words, in a proper asset allocation, all major portfolio fluctuation factors should be accommodated in some way.  In my opinion, there is a smart way to accommodate currency risk.  First, a brief mention of the not so smart way.

The Foreign Currency Exchange (This Would be the “Not Smart” Way)

If you have the day trader mentality then the foreign currency exchange is for you.  Head on over to www.forex.com and you can speculate in currency exchange rate fluctuations almost 24/7.  Except for a small window from Saturday to Sunday, the foreign exchange market is always open somewhere around the world.  For a few hundred dollars you can open an account and buy/sell currencies, hoping to make money on a currency exchange rate movements that favor your position.  The only hitch is that you need to guess right on which way the currency you favor is moving with respect to another currency.  The favorite match-up of course is the dollar/euro but you can speculate on lots of others as well.  You don’t pay commissions.  Instead, Forex makes money on the bid/ask spread when positions are closed.  (If you don’t understand this then you definitely need to stay away from this method.) 

You can leverage your cash positions and therefore lose all the money in your account in a hurry if your speculation is wrong.  Fortunately, you won’t be subject to margin calls because Forex will automatically close out your trading positions if your account balance drops to zero.  Gosh, thanks a lot! 

This is not for the long term investor so let’s move on to other ways of building currency protection into your portfolio.

Other Currency Investment Options

If you are thinking that international stock funds are the way to go, keep in mind that many of these funds are hedged, meaning that they attempt to compensate for (hedge against) currency fluctuations.  These won’t work for the currency-risk component of your portfolio. 

There also are mutual funds that are specifically managed as a currency play option against the dollar, e.g., they are bearish against the dollar as compared to foreign currencies.  Rydex Dynamic Weakening Dollar ( RYWDX) and Profunds Falling U.S. Dollar (FDPIX) are two examples.  However, they have expense ratios of 1.67 percent and 1.43 percent, respectively.  These funds are really for speculators, not long-term investors.

Yet another option is to put some of your money in foreign single-currency CD’s or currency indexed CD’s.  You can buy these at some banks, including www.everbank.com.  I think this option overly concentrates the risk and/or requires too much work and management.  The duration of the CD’s is also a problem.  What you want is something that spreads the risk and leaves the work to others.

Your Smart Currency Investment – Non-Hedged Foreign Bond Funds

I recommend that you allocate some of your long term portfolio to a mutual fund or ETF that invests in high quality bonds issued in a foreign currency and that is not hedged.  This gives your portfolio some protection against a falling dollar because as the dollar falls against the currencies represented by foreign currency bonds in the fund, the value of your fund shares increases.

Right now, there are very few options for investing in non-hedged foreign bond funds.  The fund that Mr. ToughMoneyLove owns is the Lehman International Treasury Bond ETF (BWX).  I like this fund because it invests in foreign treasury bonds.  (You would think that these would be low risk.)  It is non-hedged (which is what you need.)  And, it is an index fund so it can keep its expenses down to a reasonable .50%. 

Year to date BWX is up 6.06%.  It won’t always be this way but your objective is to include this as part of an overall allocation of portfolio assets that are non-correlated.  This is the best long term strategy to weather all kinds of bad news in the markets.  A fund like BWX can help with this strategy.

So please acknowledge and accept the hard truth about what currency risk can do to your portfolio.  Then do something about it – the smart way.


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Comments

2 Responses to “Currency Investing and Protection in your Portfolio – Do it the Smart Way”
  1. Excellent advice, Mr. TML. How much of your portfolio are you allocating to BWX to hedge against currency decline?

  2. MGL – I have 10% of my 401(k) funds allocated to BWX. Fortunately, our 401k plan has a self-managed brokerage account option which gives me great flexibility in investment options. Thanks for visiting.

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