How to Take Advantage of a Weak Dollar

When the dollar goes down, where should your dollars go?

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Although the dollar has experienced what some experts call a "confounding" rally lately, if you're still worried about the greenback taking a downward dive, you're not alone. At the very least, financial analysts expect the U.S. economy to grow slowly for the foreseeable future. Mix in the long-term impact of large-scale stimulus spending and mounting deficits, and your dollar-centric investments might be less secure than you think.

"We are in an environment where there is no such thing anymore as a 'safe asset,'" says Axel Merk, founder of Merk Investments and author of Sustainable Wealth. "Investors need to think beyond the traditional asset allocation model where you have a safe haven, and diversify their assets in a world that's ever less stable."

[See How QE2 Could Affect Your Money.]

The good news is that there are plenty of ways to hedge against a lackluster domestic economy and a declining dollar, whether it's simply increasing your exposure to U.S. companies with large global footprints or investing in the local currencies of growing economies. U.S. News talked with some experts about how to dull the effects of a weak dollar on your portfolio.

Beef up your exposure to blue chips. If you have big names like McDonald's, Pepsi, and General Motors in your portfolio, you already have some indirect exposure to non-dollar denominated assets. Most companies in the S&P 500 have significant foreign operations, which means they have stakes in foreign currencies. "Since the dollar has weakened and many expect it to continue to weaken, companies with income overseas will see a benefit when they translate that income back into U.S. dollars," Morningstar analyst Mike Rawson said in an E-mail.

If you don't already own some large-cap U.S. stocks, Rawson recommends iShares S&P 500 Index (symbol IVV), an exchange-traded fund that offers broad-based exposure to big firms with global reach. Aside from being one of the cheapest ETFs available with a 0.09 percent expense ratio, about 45 percent of the underlying companies' asset-weighted revenues come from outside the United States, giving investors substantial secondary exposure to international currencies.

Don't ignore emerging markets. For those looking to grow their investments with a five-year or longer time horizon, "it would be dangerous to ignore emerging markets," says Oliver Pursche, president of New York-based Gary Goldberg Financial Services. "That's where the growth is happening—Asia and Latin America. It's not Europe or the United States."

Pursche and Rawson recommend WisdomTree Emerging Markets Small Cap Dividend (DGS), an ETF that gives investors concentrated access to a group of rapidly growing economies including China and Brazil. "We like to look at small-cap emerging market companies because we think they're closer to those emerging market consumers, so they're probably going to experience growth more similar to the growth of those underlying economies," Rawson says. And because the revenue and costs of those economies stay local, investors can expect companies in the portfolio to have far less exposure to fluctuations in the U.S. dollar.

[See Fundamental ETFs Go Beyond Index Investing.]

Because international markets can be more complicated and less transparent than U.S. markets, Rawson recommends sticking to actively managed funds or fundamentally-weighted ETFs like WisdomTree Emerging Markets Small Cap Dividend. The fund weights companies based on the dividend they pay to investors rather than the traditional method of weighting based on market cap. "What you're doing is trying to shift toward quality companies that have the wherewithal to be able to pay a dividend. It's a little bit of a tilt to higher-quality firms and it gets you a little bit closer to some level of safety and comfort."

Cash in on foreign currencies. Holding a foreign currency in an overseas savings account isn't your best option for betting on currencies, Rawson says, because those types of investments won't earn you a competitive return compared with inflation. Instead, he recommends WisdomTree Emerging Markets Local Debt (ELD), an ETF that holds local currency bonds in countries such as Indonesia, Brazil, and Mexico. "What we like about this fund is that it is diversified, [and] accesses emerging markets currencies," Rawson says. "And since it invests in medium-term bonds, [it] earns more interest than a deposit account." The bottom line: If growth in emerging markets continues outpacing that of the United States, emerging markets currencies should rise against the dollar, which will be positive for the fund.