A stake in other countries’ money
If you’ve been trying to find a place to invest your money and are feeling uneasy with U.S. stocks and bonds, consider looking overseas.
You should know that an increasing number of experts are encouraging clients to boost their holdings in international currencies -- a once-rarefied market that’s become more accessible to individual investors.
The reason they’re pushing foreign currencies is simple. Rising U.S. government debt levels suggest future inflation and continuing devaluation of the dollar. That spells an opportunity for investors willing to take a chance on foreign money that often becomes comparatively more valuable as the dollar slides.
“There is no question now is the appropriate time to investigate some allocation to foreign currencies, if you haven’t already,” said Richard Weiss, executive vice president and chief investment officer at City National Bank in Los Angeles. “If you wait until everybody is talking about dollar devaluation, you’re too late. The opportunity is now.”
Foreign currency trading, which essentially involves buying the debt of foreign countries (much as foreign investors buy U.S. Treasury bills and bonds) is, well, foreign to most individual investors.
That’s largely because it was once primarily done by only super-wealthy individuals and institutions through bank currency trading departments. However, over the last few years, it’s become widely accessible for even middle-income investors through two vehicles -- exchange-traded mutual funds and bank certificates of deposit.
Exchange-traded funds can either buy the currencies directly or buy options and futures contracts that obligate them to buy baskets of currencies in the future. The more speculative these funds become in investing in futures contracts, the more widely their returns can swing.
For those who can’t handle that type of volatility, there’s the certificate of deposit option offered by Jacksonville, Fla.-based EverBank. EverBank offers short- and long-term certificates of deposit that can be denominated in any one of a dozen foreign currencies.
These CDs are insured by the Federal Deposit Insurance Corp., but that does not protect them from investment loss.
What the FDIC is protecting, in this case, is the value of your investment if the bank fails. But the value of the foreign currencies in your account could rise or fall, depending on the relative strength of the U.S. dollar against the currency you have selected.
Say, for instance, that you invest $20,000 in a one-year CD denominated in British pounds and it pays 5% interest. You give your $20,000 to EverBank and the bank converts it to pounds at the going exchange rate. A year later, you have $1,000 in interest, but your entire account is denominated in British pounds. But to spend that money in the U.S., you need to exchange the pounds back into dollars.
If the British pound has gained against the U.S. dollar, you get a double benefit -- a return on the currency swing as well as on your investment. If the pound has gained by 5% against the dollar during that period, you come home with $22,050 -- a 5% return on your initial $20,000 investment, plus a 5% return on the $21,000 you’re converting into U.S. dollars.
If, however, the British pound slides in value against the dollar, you could end up with a loss -- despite the investment income. If the pound loses 10%, for example, you have just $18,900 -- the $21,000 you had in pounds minus the currency exchange loss of 10%, or $2,100.
Don’t want to risk losing any of the money in your CD? EverBank also has a hybrid product that will allow you to bet on the currencies of Brazil, Russia, India and China as a group, without risking your principal.
Called the BRIC CD, it allows you to deposit as little as $1,500 and get 100% of the upside of the appreciation of those currencies without any risk to your initial investment. At worst, your CD will be worth the amount of your initial deposit at maturity.
The downside: It’s a three-year commitment and there’s no getting your money back early, said Chuck Butler, president of EverBank World Markets. The only instance that they’ll pay out early is if you die and your estate has asked for the cash, he said.
In addition, the CD doesn’t earn interest. The return is based solely on the appreciation of those securities against the dollar. Your return is based on the notion that you put 25% of your initial investment in each currency. If they gain, on average, you win. If they don’t, you earn nothing -- but lose nothing.
More popular are the bank’s single-currency CDs, particularly those that are tied to “commodity currencies,” Butler said. Commodity currencies are those issued by countries that attribute a substantial portion of their gross domestic product to agriculture, oil or precious metals, he explained.
Those countries, such as Australia, New Zealand, Brazil and Canada, are expected to do well in an inflationary environment.
But Weiss believes that buying commodity currencies is chasing last year’s returns -- a risky strategy that’s as likely to be a loser as it is to produce a profit.
In fact, he likens betting on one country’s currency to betting on one stock. It’s just too risky for the average investor.
He prefers the idea of investing in a broadly diversified basket of currencies. That, he says, is smart for your entire portfolio.
Adding a modest amount of foreign exposure to your portfolio has been shown to increase returns while actually lowering risk, because foreign currencies are not closely correlated to the U.S. stock or bond markets, he notes. That makes your entire portfolio a little more stable.
“Over one to three years, we think foreign currencies are likely to be a return enhancer,” Weiss said. “It allows you to not only sidestep inflation and dollar devaluation but take advantage of it.”
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