One of the most proven and widely accepted axioms of investing is diversification. The rational saver will choose a combination of equity, fixed income, and alternative investments such as real estate funds that match the returns they anticipate and the risk they’re willing to accept. What many people, financial advisers included, don’t immediately think to diversify is the currency they invest in.
The current economic environment has pushed the interest rates on U.S. Treasury bills and bonds to an unprecedented low. This has led to a strong dollar internationally, despite the fact that the national debt is quickly becoming the biggest domestic issue in the United States. Meanwhile, the Federal Reserve is printing massive amounts of U.S. dollars, expanding its balance sheet in an effort to kickstart the American economy.
As the global economy returns to growth and the government continues to drag its feet on coming up with a solution to the United States’ budget woes, many experts are predicting that inflation may become an issue for investors in the medium to long term. This would mean less purchasing power for the cash that one has on hand and lower real returns on their investments.
One recommendation that has been gaining steam to mitigate against these risks related to the dollar is to get exposed to the national debt of other countries. In other words, to invest in foreign currencies. In the past, the Over-The-Counter ForEx market was often seen as too opaque, intricate, and even speculative for the retail investor. Not only would investing in a currency like the Iraqi Dinar be risky, it would also be mostly unnecessary due to the strength of the dollar. But these potential weaknesses in the dollar coming to light, in combination with an increasing ability to spread one’s savings across the globe, make it easier, cheaper, and perhaps wiser for the saver to spread their assets beyond domestic borders.
In addition to Exchange Traded Funds and other vehicles that offer financial products based on international currencies, many financial institutions make less volatile instruments available to people who are wary of the U.S. dollar’s future. A CD, for instance, can be purchased that is based on the currency of one or several foreign countries. If the country’s currency gains against the dollar, its returns will add to the stated interest rate on the deposit. Its standard deviation will be lower than an international ETF or mutual fund, and it can be seen as a “straight” hedge against currency risk in America.
The smart saver will talk to their financial adviser to explore their currency-diversifying options. Like more traditional diversification, one wants to make sure their entry into the international financial realm fits into their risk tolerance targets and money growth goals for the future.
February 11, 2016