If you watch the news you have probably heard a lot about dollar depreciation these last few months. As part of the economic stimulus package, the Federal Reserve has had to keep interest rates at historic lows (thereby making the “price” of dollars very cheap) while borrowing enormous quantities of money from foreign and domestic lenders. These actions have weakened the dollar against several foreign currencies.
As a savvy investor, you should be worried about the decline of the dollar, because this directly hurts the value of your paycheck. However, like everything else in life, economic trends have two sides to them. In our case, dollar depreciation can actually be your opportunity to invest in other currencies. Even if you’re not particularly concerned about the recent decline, investing in foreign currency will help you to diversify your portfolio, which is always a good idea.
The most important thing to remember is that investing in a foreign currency must never be considered in isolation, so mind its impact on your entire portfolio. For example, let’s say you have $20,000 in U.S. investments and you read an article that is very positive on Brazil. Should you go ahead and invest $5000 in Brazil? If you do, you will have 20% of your overall investments in only one country. Ask yourself if you want that much exposure, especially since the Brazilian stock market is known to be quite volatile.
If however, you are still interested after careful consideration of your own investing portfolio, here are a few suggestions to gain exposure.
- Stock of Companies with Multinational Operations – Many big American companies derive a huge portion of their revenues from abroad. This means that when foreign currencies do well versus the dollar, the profits and stock prices of such companies get a boost. Examples of such companies are Coca Cola, Microsoft, IBM, Pfizer, McDonalds etc.
- Foreign Currency ETFs – These trade just like stocks on American stock exchanges and are backed by baskets of foreign currencies. In other words, owning a Euro ETF is like owning a money market account in Europe. CurrencyShares have a wide range of ETFs that provide exposure to different currencies. Another example is the SPDR Barclays Capital International Treasury Bond ETF. Make sure to check an ETF’s liquidity and trading commissions before buying it.
- Foreign Bond Funds – These mutual funds invest in bonds issued by foreign governments, i.e. they receive interest payments from foreign governments in foreign currency. As the foreign currency strengthens, the value of the interest payments converted into dollars goes up. Examples of such funds are Templeton Global Bond Fund and Aberdeen Global Income fund. Do watch out for high management fees and other costs before you purchase any mutual fund.
- Foreign CDs and Savings Accounts – Some American banks (notably Everbank) offer CDs denominated in foreign currencies. These CDs offer a higher rate of interest than dollar-denominated CDs, but carry the risk of exchange rate fluctuation, i.e. you may get back fewer dollars than you put into the CD if the dollar strengthens instead of weakening against the foreign currency. Currently, the 1-year Everbank WorldCurrency Australian Dollar CD offers 3.5% whereas the most competitive 1-year US CDs offer less than 2%. Unfortunately there is a high minimum amount you need to invest to open a WorldCurrency CD (around $10,000). Also note that all Everbank CDs are FDIC insured. So even though it does not protect against currency fluctuation risk, you are protected in the case that the bank becomes insolvent.
It is important to make sure that all foreign currency investments match your ability to take on risk. Go with reputable institutions and read the fine print on all your investments before you sign the dotted line.
I’d love to hear of any other ideas you may have about investing in foreign currencies, or any questions about the logistics of investing in the above.