Even if you think you don’t know how to invest in currencies, you are probably already doing so indirectly.
For example, if you own any large mutual or exchange-traded funds (ETF) that invest in U.S.-based blue-chips, you already own international juggernauts like McDonald’s Corp. (NYSE: MCD) or Procter & Gamble Co. (NYSE: PG). That means your returns fluctuate on the strength of foreign currencies where these companies do business.
When the dollar is weak, international stocks and bonds are worth more in dollars.
And when the greenback gains, returns shrink.
So whether you know a rupee from a ruble doesn’t matter – you’re playing the currency game.
But knowing how to invest directly in foreign currencies can provide a valuable edge against the eroding purchasing power of the dollar.
Here’s how to invest in today’s currency markets and gain a valuable hedge against your dollar holdings.
How to Invest in Currencies
Forex trading: Forex trading is the largest market on the planet, with more than $3 trillion traded daily.
Simply put, the Forex market is the simultaneous buying of one currency and selling another.
Until recently, currency trading was limited to giant international banks, multi-national companies, hedge funds and large speculators.
But with the explosive growth of retail Forex dealers like TD Ameritrade Holding Corp. (NYSE: AMTD), you can trade global currencies with as little as $1,000.
Keep in mind, however, you’re not trading stocks and bonds here. There’s no regulated currency exchange and no central clearing house.
All trades are done through dealers and banks and costs are hard to figure — money gets made on spreads between the bid and ask prices, not on fixed-rate commissions.
Most importantly, the Forex market requires average margins of only 1% — you can control a $100,000 contract with measly $1,000 in capital.
So Forex trades offer lots of leverage with potential for significant profits – and losses.
Please note – Forex trading is truly not for the faint of heart.
For instance, when the euro lost more than 15% of its value against the dollar during the sovereign debt crisis many speculators got hammered.
ETFs, ETNs: Wall Street firms like Rydex, WisdomTree, and ProShares all offer single and multiple currency ETFs and exchange-traded notes (ETNs).
These trade like stocks and track the performance of one or more currencies in the same way that many index funds track the S&P 500 index.
Keep in mind that profits from currency-based ETFs and ETNs are taxed as ordinary income — typically a higher rate than capital gains.
CDs, Savings Accounts: Some banks offer certificates of deposit (CDs) that earn interest at local rates in specific countries.
Everbank.com offers a World Currency and a basket CD that includes a mix of various currencies. Like all CDs your money is tied up and there are penalties for early withdrawal.
It also offers a foreign currency account that functions like a money market and allows the transfer of money between major currencies.
Foreign Bond Funds: These are mutual funds that invest in foreign government bonds and earn interest in foreign currency. If the foreign currency goes up in value, the earned interest increases when converted back to dollars.