The U.S. dollar has lost ground over the past ten years relative to the other major world currencies. This trend is likely to continue. Prudent retirement investors may want to allocate a part of their portfolio to foreign currencies to provide protection or take advantage of positive movement of foreign currencies against the dollar. Here are several options for investing in foreign currencies.
1. Trading on the foreign currency exchange. Foreign exchange trading is heavily advertised to U.S. investors. But the foreign currency exchange may not be a wise move for the average retirement investor. Like day trading stocks, foreign exchange trading is a time intensive activity and carries many risks.
On a foreign currency exchange 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. A few hundred dollars will open an account from which you can buy and sell currencies. You make money on currency exchange rate movements that favor your positions. The problem is that you must correctly guess the direction the currency you favor is moving with respect to another currency.
A favorite match-up is the dollar and euro, but you can speculate on lots of others as well. You don't pay commissions. Instead, the foreign currency exchange (Forex) makes money on the bid or ask spread when positions are closed. If you don't understand what this means, then you definitely need to avoid this option. On the Forex you can leverage your cash positions and quickly lose all the money in your account if your speculation is wrong. This is not a smart strategy for the long-term retirement investor.
2. International stock funds. Some investors believe that owning international stock funds provides protection against a declining dollar. This is not always the case because many international equity funds are hedged, meaning that they attempt to compensate for or hedge against currency fluctuations. Therefore, these funds won't work for the currency-risk component of your portfolio.
There are mutual funds that are specifically managed as a currency hedge against a weakening dollar, such as Rydex Dynamic Weakening Dollar (RYWDX) and Profunds Falling U.S. Dollar (FDPIX). These funds are bearish against the dollar compared to foreign currencies, but have extremely high expense ratios of 1.68 percent and 1.73 percent, respectively. They are really for speculators, not long-term investors.
3. Currency hedged CDs. Another falling dollar protection option is to purchase a foreign single-currency CD or a currency indexed CD. You can buy these specialized CD products at some banks, including EverBank. However, this option may overly concentrate your risk or require a significant amount of work and management. The duration of the CD may also be a problem. I prefer a strategy that spreads the risk and leaves the work to others.
4. Non-hedged foreign bond funds. The strategy that I prefer is to allocate some of your long-term retirement portfolio to a mutual fund or ETF that invests in high quality bonds issued in a foreign currency and is not hedged. This provides some protection against a weakening U.S. dollar. As the dollar falls against the currencies represented by foreign currency bonds in the fund, the value of the fund shares increases.
There are very few options for investing in non-hedged foreign bond funds. One fund that can work is the SPDR Barclays Capital International Treasury Bond ETF (BWX). A benefit of this fund is that it invests in foreign treasury bonds. The assumption is that most foreign treasury bonds would be low risk. This fund is also non-hedged, a feature that is necessary to provide maximum protection against a declining dollar. Because it is an index fund, it can keep its expenses down to a reasonable 0.5 percent.
The fall of the dollar relative to other currencies is likely to continue. You should protect your retirement nest egg from this decline with a specific strategy that will allow you to avoid a painful reduction in your future spending power.
Mark Patterson is an engineer, patent attorney, baby boomer, and author of The Failsafe Retirement System. He blogs on matters of personal finance and retirement planning at Tough Money Love and Go To Retirement.