Investors are jittery about the declining U.S. dollar, and rightfully so, but where's the best place to park your money?
Though the greenback had a brief resurgence last winter, 2009 has seen the dollar drop against the British pound (8%), the Canadian dollar (12%) and even more against emerging-market currencies like the Brazilian real (23%). With America's economy facing a ballooning trade deficit and ultralow short-term interest rates for the foreseeable future, a rowdy recovery isn't likely.%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%%"I don't think we're going to see that firm basis of the U.S. dollar ever again," says Dr. Todd Hanson, a quantitative strategist who specializes in exchange rates at New York-based Team Trading. "That thing's been sinking like a stone for the past two years."
So what's an investor to do? One way to maintain the value of your portfolio in the face of future dollar declines is to hedge by gaining exposure to foreign currencies, either by investing in the currencies themselves, or through buying stocks in companies whose earnings aren't denominated in dollars. And, with the deadline for harvesting your stock market losses for a tax deduction approaching, now is an excellent time to rebalance your portfolio.
Deciding where to put that money abroad can be a difficult choice. Developed economies like the U.K. and France offer stability but are grappling with rising unemployment and debt, just like the U.S. Developing countries like Brazil offer more potential for growth, but come with risk, which can send many investors scattering at the first sign of a crisis – and can send the currency off a cliff, as briefly happened with the real during the winter of 2008.
Hedging the Greenback with ETFs
Hanson recommends taking the middle road and buying the currencies of commodity-rich New Zealand and Australia -- advanced economies with more room to grow than the U.S. or the U.K. -- through ETFs like the CurrencyShares Australian Dollar Trust (FXA). "The Aussie dollar and the [New Zealand] kiwi are the best bang for your buck these days," he says. "Those particular countries are high in natural resources like gold, gas and oil ... a good, safe bet, but with room for growth."
Another approach to currency -- one favored by buy-and-hold investors -- is not to bet on the currency of a single country or region, but to purchase equities in an array of foreign markets all at once, thus avoiding the risk of buying currency directly.
"There are several downsides to just owning the currency," says Mary Malgoire of The Family Firm, a Bethesda, Md., financial advisory firm. "There is a cost to buy and sell it; it earns no interest unless held in an interest-bearing account."
She suggests stocking up on low-fee, broadly diversified exchange-traded funds that track foreign indexes, such as the Vanguard Europe Pacific ETF (VEA) and the Vanguard Emerging Markets ETF (VWO). The first offers access to the developed markets of Europe and Australia; the second gives heavy exposure to higher risk, higher reward bets like China, India and Brazil. Both ETFs essentially offer a basket of companies whose earnings are denominated in foreign currencies -- earnings that will get a tailwind when translated back into declining dollars.
Malgoire advocates a two-to-one ratio of U.S. equities to foreign equities for most investors, with a quarter of that international allocation placed in emerging markets. Just make sure to do a little homework, or you risk committing a counterproductive cardinal sin.
"The investment must not be hedged to the dollar," warns Malgoire. "Some mutual funds hedge the currency risk and this costs the portfolio money and eliminates benefits that can come from a declining dollar."
Introduction to Preferred Shares
Learn the difference between preferred and common shares.View Course »