Investing in Currencies

July 13, 2010 by  
Filed under Asset Allocation, Commentary, Investment Planning

Investment managers use many different assets to construct portfolios.  One of the top tools for mitigating risk is good old-fashioned cash.  However, cash does not always have to be in US Dollars.  Investors can store their hard-earned savings in other currencies, too.  But currency values fluctuate; so foreign currencies are usually differentiated from cash as an asset class.

Currencies are unlike other assets.  For instance, currencies are used for monetary exchange across the globe.  People don’t buy groceries with gold coins or mutual funds in France – they use Euros.  That’s the way we usually think about currencies.  But currencies can do more than buy groceries.  If you’re a US-based investor, your investment account can gain value when holding a currency that appreciates against the US dollar.  Your account can also profit while a currency is going down if you sell-short in that currency.

All of the major world currency values float against each other, though some float less than others (ex. Chinese Yuan).  Investment managers use these major currencies to diversify investment accounts.  The major currencies ranked by trading volume are:

  1. US Dollar (USD)
  2. Euro (EUR)
  3. Japanese Yen (JPY)
  4. British Pound Sterling (GBP)
  5. Swiss Franc (CHF)
  6. Australian Dollar (AUD)
  7. Canadian Dollar (CAD)

Investment managers buy or sell currencies in various ways.  The easiest and most cost-effective way to hold currencies is through ETFs.  The most popular are CurrencyShares from Rydex.  There are several competitors, but none have the trading volume that Rydex has garnered.

For example, an investment manager could use a currency ETF when he sees weakness in the US market.  If he observes a stronger Japanese market in the intermediate-term, he could buy CurrencyShares Japanese Yen Trust (FXY).  If he’s right, the investment would appreciate as the US Dollar fell versus the Japanese Yen. FXY would go up since the ETF is priced in Dollars.

Another way investment managers use currencies is through non-US dollar savings accounts.  Like any bank account, you deposit money in a bank and receive a rate of return.  But unlike other bank accounts, the funds are counted in a different currency.  Your deposit will fluctuate in value if that country’s currency fluctuates while your cash is on deposit.  There are various risks associated with this strategy, so make sure your investment manager is doing his homework.  If you want to make international savings deposits yourself, check out Everbank.

By the way, if you’re curious about how the Dollar matches up with other currencies, check out these exchange rates.

Comments

2 Responses to “Investing in Currencies”

  1. Tweets that mention Investing in Currencies | Invest With An Edge -- Topsy.com on July 13th, 2010 1:45 pm

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  2. Lorne Marr on July 21st, 2010 5:21 am

    In my opinion, currency trading is one of the safer ways to positive return, because it is not a zero-sum game. I am basing this assertion on the fact, that apart from regular market traders, there are people who enter this market unknowingly, as tourists. If you travel to a different country, you have to buy their currency and you seldom ask questions about the optimal timing or can afford to wait at all. Same applies to businesses (especially those who don’t hedge).
    Therefore, tourists will always pay you the premium and as an active trader, you can expect to earn at least a minimal return in the long run.

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