Exchange Traded Funds (ETFs) have been growing in popularity with investors and their advisers. They offer low costs and opportunities to more precisely create an asset allocation or take advantage of trading and hedging ideas.
Currency Exchange Traded Funds have grown popular over the course of 2011 to investors who are attempting to gain exposure to foreign currency while avoiding the cost and complexity of the foreign exchange (Forex) market. Investing in foreign stocks and bonds can be a good investment when looking for a financial diversification and also offer the potential of producing substantial returns.
Up until recently, an investor’s only choice to hedge foreign exposure has been through the Forex markets. These markets can be complex for most investors and require substantial capital at risk. Investing in Forex is promoted by some as a speculative way to make profits. But an investment in foreign currency comes with the risk of losing money through exchange rates.
ETF’s that focus on currencies are a less complex way to hedge an overseas investment. They give the average investor the opportunity to invest away from the US dollar. ETF’s are also used as ideal instruments for investors to diminish the loss of money due to exchange rates.
Why Invest in Currency Exchange Traded Funds?
Investing in an ETF is much less complex than investing in the Forex market. Although the Forex is the most liquid market (trillions are traded each day), it can be difficult for the average investor to get a seat at the table considering the capital that may be needed and the trading costs incurred. ETF’s offer a simpler way to invest in foreign markets.
If an investor feels as though there is potential economic growth overseas or in an emerging market, ETF’s are a perfect vehicle for international exposure. Buying individual stocks overseas may be difficult for US investors and may be costly as well. Mutual funds are a great way to gain access but they have higher costs compared to ETFs.
Why invest in currencies? Consider this: Living in the US means that your source of income and most of your investments are denominated in US dollars. If your portfolio is loaded with domestic investments (and most investors tend to be woefully under-allocated in foreign equity positions), adding a currency ETF to your portfolio can help balance your investments and add diversity to your portfolio away from the US dollar.
Let’s say you are investing overseas through mutual funds in your 401(k) or brokerage account. Most of these portfolio managers tend to not hedge their exposure to currency changes. This can turn a positive fund return into a loss when converting back to the US dollar.
Now an investor may want to hedge by holding a position in a foreign currency. But investing in foreign markets can be risky because of the constant fluctuation of currency and exchange rates. The currency market never closes and is open twenty-four hours of everyday. For the average investor, constantly keeping up with the currencies to figure out the best times to sell and buy may not be worthwhile and result in a loss in money (as well as sleep). ETF’s offer a more efficient opportunity to manage these risks of foreign investments.
Why bother? Well, just look at the news headlines. There continues to be debt crises in foreign and US markets. This tends to lead to potentially higher interest rates as investors demand a higher return for attracting their money to a particular country. Higher interest rates in turn will negatively impact the value of the currency and lead to a “weaker” currency. (The upside, on the other hand, is that a weak dollar, for example, will make our exports more competitively priced and help those business dealing overseas).
Investors may be interested in “safe haven” currencies during poor financial times. Countries with strong political stability, low inflation, and stable monetary and fiscal policies tend to be magnets for money in tough times. While that doesn’t necessarily describe the US right now, we are still considered the best option out there as a “safe haven.”
Hedging Examples
According to this article appearing on Investopedia, “a weakening currency can drag down positive returns or exacerbate negative returns in an investment portfolio. For example, Canadian investors who were invested in the S&P 500 from January 2000 to May 2009 had returns of -44.1% in Canadian dollar terms (compared with returns for -26% for the S&P 500 in U.S. dollar terms), because they were holding assets in a depreciating currency (the U.S. dollar, in this case).”
Disadvantages of ETF’s
No investment comes without risks and ETFs and currency ETFs in particular are no different. As is the case with many ETFs, there is always the issue of liquidity of the ETF. (An ETF without a deep market or volume can produce exaggerated and volatile price changes). And in the case of currency ETFs there is the added issue of dealing with foreign taxes.
The Bottom Line
Whether or not a currency ETF makes sense for your particular situation is something that only you with the help of a qualified professional can determine.
But you should at least be aware of the tools available that may help you protect your portfolio. At the very least, it makes sense to hedge overseas investments especially during volatile times.
Buckle Up and Hold On: Investment Roller-Coaster Ahead
Posted in 10 Most Common Investing Mistakes, Economics, Investing Strategy, Market Commentary, Risk Management, The Money Road Map, tagged Asset Allocation, Debt Crisis, Economic Indicators, ETF, financial planning, Hedging, inverse ETF, Market Meltdown, Rebalance Your Investments on August 5, 2011| Leave a Comment »
When you’re on an airplane and hit turbulence or rough weather, the flight crew tells you to stay seated and buckled. Unfortunately, when the markets hit bad weather, there is rarely such a warning.
You might want to call it “Black Thursday.”
Yesterday, the markets around the world went into a tailspin reacting almost violently to the ongoing drumbeat of dour economic news.
On the radar, we’ve seen the storm clouds moving in for a while now:
There was a temporary distraction over the last couple of weeks as we in the US focused on the debt ceiling debate to the exclusion of all else. Self-congratulatory press remarks by politicians aside, nothing done in Washington really changed the fact that we are still flying into a stiff head wind and storm clouds that threaten recovery prospects.
Eventually, though, the accumulation of downbeat news over the past few weeks seems to have finally come to a head yesterday. No one thing seems to have caused it. It just seems that finally someone said “the Emperor has no clothes” and everyone finally noticed the obvious: global economies are weak and burdened by debt and political crises.
All of this has been creating doubt in the minds of investors about the ability to find and implement policies or actions by governments or private sector companies. And doubt leads to uncertainty. And if there’s one thing we know for certain, it is that markets abhor uncertainty.
While many commentators may have thought that the “resolution” of the debt ceiling debate in Washington would have calmed the markets, it seems that upon further review of the details the markets are not so sure. And in an “abundance of caution” market analysts who once were so OK with exotic bond and mortgage investments are now reacting overly negatively to any and all news and evidence of weakness by governments or companies.
What’s An Investor to Do?
Don’t panic. It may be cliché but it’s still true. If you hadn’t already put in place a hedging strategy, then what is past is past and move forward.
So the Dow has erased on its gains for 2011 and has turned the time machine back to December 2008.
If you sell now — especially without a plan in place — you’re setting yourself up for failure.
Here’s a simple plan to consider:
As a side note: The old stockbroker’s manual still says “Sell in May and Go Away.” Probably for good reason. Historically, the summer months are filled with languid or down markets and volatile ups and downs.
While it’s tempting to give in to the emotional “flight” survival response that you’re feeling right now, don’t give in. Stand and fight instead. But fight smart. Have a plan and consider a professional navigator.
If you are seeking a second opinion or need some help in implementing a personal money rescue plan, please consider the help of a qualified professional.
Let’s Make A Plan Together: 978-388-0020
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