Hedge The Falling Dollar By Investing Abroad

March 3rd, 2008 · No Comments · Subscribe to this feed

Let’s face it: the dollar is weak and seemingly getting weaker by the day, with currency experts forecasting it will get worse before it gets better. While I don’t buy into the “end of the dollar” hysteria, I do think it’s prudent to hedge your bets. There are a few simple ways you can benefit from a falling dollar.

Invest Abroad

Probably the easiest way to hedge against the falling dollar is to invest in foreign stock mutual funds. Most foreign stock funds are unhedged, meaning they own foreign stocks directly on foreign exchanges and in foreign currencies. If the dollar falls relative to those other currencies, you gain even if the underlying stocks don’t budge in their own currency. For example, suppose you buy Toyota (TM) stock on the Tokyo Stock Exchange and that it appreciates 8% next year as measured in Yen. If the dollar also falls 5%, your total return is 13% plus any dividends you may receive. As an added bonus, foreign stocks are not always highly correlated with American stocks, so investing abroad should increase returns and reduce risk over the long term.

Just like their domestic cousins, foreign index funds usually have low expenses, better tax efficiency, and higher returns than most actively-managed funds. You should avoid buying single country or region funds, though, since that would expose you to too much political and market risks. I recommend Vanguard’s FTSE All-World Ex USA index fund (VFWIX) for up to 50% of your stock allocation.

Lend Money to Foreigners

Foreign bond funds can also be an effective dollar hedge for those who don’t want to take a lot of equity risk. Many foreign bond funds hedge their currency exposure so it’s important to find an unhedged fund if currency diversification is your goal. When in doubt, check the prospectus. Foreign bonds can also be good diversifiers since they don’t always move in sync with domestic bonds. Unfortunately, I don’t know of any foreign bond index funds, but T Rowe Price International Bond (RPIBX) is a reasonably priced and well-managed fund that should do well going forward. It is also unhedged so you will reap the full benefits of a falling dollar.

Some Things NOT to Do

I highly suggest you don’t get involved in the Foreign Exchange (FOREX) market like you hear about in all those late-night infomercials. The FOREX market is dominated by sophisticated institutions like banks, insurance companies, and multinational corporations. The small individual investor has practically no chance of long-term success against the big guys. I also don’t think opening a bank account in another country is worth the trouble.

You should also be wary of Emerging Market bond funds. Sure, they’ve had some pretty amazing returns lately but they are also extremely risky. Emerging market governments tend to default on their bond obligations with alarming regularity. If you DO choose to invest in emerging market bond funds, I would limit it to 5% of your portfolio.

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