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How to Invest in Foreign Currency, Without Leaving the Country
Posted On March 1, 2011 @ 6:00 am In Personal Finance | 2 Comments
In a global economy, the dollar won’t always be on top. Will your savings be protected when it falls? Where to Put Your Money NOW author Peter Passell highlights three ways to shore up your retirement portfolio with overseas securities.
The very idea of investing in foreign currencies seems exotic and dangerous, an adventure best left to the professionals. But the ongoing integration of the global economy, along with the introduction of inexpensive ways to invest abroad, has radically altered the landscape. Much of what you buy is made in countries with other currencies, so the exchange rate between the dollar and those currencies now directly affects your living standard. Yet, oddly, many investors who are careful to hedge their bets in U.S. securities never think to diversify their portfolios into other major currencies.
There’s an important distinction between investing in foreign stocks and investing in foreign currencies. Foreign stocks do change in value as the exchange rate of the dollar changes. But a whole host of other factors also affect foreign stock prices. By contrast, buying safe bonds with short maturities (thus not subject to much market risk) is a pure currency “play” — a bet that the foreign currency will rise in value against the dollar.
Is there a good reason to bet that the dollar will fall in value? I think so. The dollar is overvalued in the sense that, at the current exchange rate, foreigners buy far less from us than we do from them. So, at present, foreigners (or their governments) must inevitably amass vast quantities of dollars (nearly $800 billion last year). And when (not if ) they get tired of trading their TVs and cars and oil for the chance to buy U.S. Treasury securities, the exchange value of the dollar will fall.
But even if you aren’t as sure as I am that the dollar will eventually tank, it still makes sense to put some of your savings into securities denominated in other currencies. Think of it this way: by keeping all your assets in dollars even though so much of what you buy comes from Asia and Europe, you are effectively betting that the dollar will appreciate.
A decade ago, buying safe, fixed-income securities in other currencies was not practical unless you had a lot of money to invest. Now, options abound.
Foreign Bond Funds
Lots of bond mutual funds buy securities in other countries. Most of them, though, are just looking for higher interest rates and don’t want to risk changes in the value of their assets as exchange rates vary. Luckily for them, there are sophisticated (if not always cheap) ways to neutralize exchange risk. But a few funds deliberately expose their shareholders to the risk of changes in exchange rates — precisely what we want as a means to hedge against the decline of the dollar.
Oppenheimer International Bond Fund. This fund does just what you’d like it to, investing in high-quality bonds denominated in diverse foreign currencies. I have to grit my teeth to recommend it, however, because the fees are so large: first a 4.75 percent sales charge, then close to 1 percent in annual management fees. Buy it only if you plan to hold for several years, if you buy it at all. Visit oppenheimerfunds.com or call 1-888-470-0862.
American Century International Bond Fund. Much like the Oppenheimer fund; invests in a mix of bonds, mostly in Europe and Japan, with average maturities of about five years. Like Oppenheimer, it charges a 4.75 percent initial sales charge. The one exception: anyone who owned American Century mutual fund shares before September 28, 2007. Visit americancentury.com or call 1-888-345-2071.
Foreign-Currency-Linked Bank CDs
An online bank called the EverBank specializes in federally insured CDs with maturities up to twelve months that rise and fall in value with the exchange rate between the dollar and any of a dozen currencies. Don’t worry about how they get the federal insurance — the whole thing is on the up-and-up. The only drawbacks: relatively low interest rates and a $10,000 minimum investment. Visit everbank.com or call 1-800-926-4922.
Foreign-Currency Exchange-Traded Funds
There seems to be an exchange-traded fund for every financial index these days, so why not some ETFs that track the exchange rate of the dollar with other currencies and pay a little interest, besides? Why not, indeed.
Sharp-eyed investors will note that some ETFs tracking exchange rates and other indexes are actually ETNs — exchange traded notes. The difference is small, but not insignificant. ETNs are uninsured loans to banks, which give you a little interest plus a link between the value of the principal and a specific financial index. So ETNs should generate slightly higher returns than equivalent ETFs, but shareholders must live with the (small) risk that the bank will default on the loan. In the spirit of conservative investing, I’d generally opt for ETFs unless an ETN offers a unique investment opportunity.
The most popular way to invest in currency ETFs is one currency at a time — which leaves the question of which currencies to buy and in what proportion. If you spend a lot of time (and/or money) in another country — for example, if you regularly visit relatives in Canada — it probably makes sense to buy the relevant single-currency ETF. Otherwise, you may be better off with an ETF that buys a whole package of currencies.
PowerShares DB G10 Currency Harvest Fund
Tracks an index of ten major currencies that is maintained by Deutsche Bank, the giant German bank. High management fees for an ETF. Visit invescopowershares.com or call 1-800-983-0903.
The investment company Rydex manages individual exchange traded funds for euros, Japanese yen, British pounds, Swedish krona, Swiss francs, Canadian dollars, and Mexican pesos. Management fees aren’t bad. The funds track exchange rates with the dollar quite closely and pay whatever interest they can earn in safe, short-term bonds in the currency. For information, visit currencyshares.com.
WisdomTree Dreyfus Currency Income ETFs
This brand of ETFs tracks a host of individual currencies — notably currencies of three emerging-market powerhouses, China, India, and Brazil. Visit wisdomtree.com.
Barclays GEMS Asia 8 ETN
This new exchange-traded note tracks an index of the Indonesian rupiah, the Indian rupee, the Philippine peso, the South Korean won, the Thai baht, the Malaysian ringgit, the Taiwanese dollar, and the Chinese yuan. Downside: high management fees, some credit risk. Best information source: etfconnect.com.
ABOUT THE AUTHOR
Peter Passell, author of Where to Put Your Money NOW: How to Make Super-Safe Investments and Secure Your Future (Copyright © 2009 by Peter Passell), is a senior fellow at the Milken Institute and the editor of the Milken Institute Review, and has been a columnist for the New York Times. He is the author of many guides to personal finance, including Where to Put Your Money, The Money Manual, and How to Read the Financial Pages.
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