Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

The Simple Ways to Profit from a Falling Dollar

The value of the U.S. dollar isn't just some nebulous concept that concerns only economists. It has a dramatic effect on your everyday life. For instance, the cost of imported goods is directly affected by the value of the dollar, and in turn, the cost of imported goods directly affects the cost of all goods and services sold across the country. So from the amount of money paid for our work, to the cost of food and gasoline, to interest rates on car and home loans, to investments, Americans constantly deal with the impact of the dollar in their daily lives.

Yet despite its importance, many Americans remain unaware of how poorly the dollar has performed as a long-term store of purchasing power. What if someone walked up to you and asked if you would like to invest your money into an asset that has lost about -4% on average since 1970? This figure represent the loss of purchasing power of the U.S. dollar over that time period.

Of course, rising wages and earnings help to offset some of this loss, but there are other ways to counter the effect that can help you profit when the dollar heads south.

Ways to Profit When the Dollar Falls
Investors should realize that whenever they make an investment -- whether they are purchasing foreign securities, buying a U.S. stock, or even a certificate of deposit, they are making a currency bet. If they make an investment in an appreciating currency, the purchasing power of the value of their investment will rise without any price appreciation. If they choose a depreciating currency, the purchasing power of their investment will fall unless helped by interest payments or a rising share price. The bottom line is that if investors get the currency right, they've won half the battle.

One way investors can protect their purchasing power is to directly trade foreign exchange -- in effect, selling a depreciating currency to buy one rising in relative value. However, the risks are high for trading currencies, and it can be difficult for new investors to learn.

A more practical option for investors that want to own a particular currency directly is through the purchase of a currency exchange-traded fund (ETF) These ETFs trade on major exchanges just like a stock and are less leveraged than trading currency directly -- meaning the risk associated with investing is lessened. Currency ETFs run the gamut from major currencies such as the euro to emerging market currencies such as the Brazilian Real and the Chinese Yuan. One example is the CurrencyShares Mexican Peso Trust (NYSE: FXM), which obviously tracks the performance of the Mexican Peso.

Another way investors can benefit from a falling dollar is by buying commodities, including precious metals like gold, to preserve their long-term wealth. Most commodities are priced in U.S. Dollars. As a result, when the dollar falls relative to other currencies, commodities typically rise.

There are, however, many investors who do not feel comfortable owning commodities like gold. Conservative American investors can invest in foreign-currency-denominated certificates of deposit (CDs) and savings accounts. There are a few banks here in the U.S. that offer this service. While deposits in these types of accounts are insured by the FDIC, investors are not insured against currency losses.

Somewhat more risky is the purchase of foreign bonds. It is extremely difficult to purchase these bonds directly. A more practical method is to buy foreign bonds either through a closed-end fund or an ETF. The choices available vary widely, and today investors can buy a fund focused on either bonds of developed countries or emerging market countries -- or a mix of both.

Finally, investors can purchase foreign stocks. This can be done in a variety of ways. The easiest way is by purchasing a fund that buys foreign stock directly. Both closed-end funds and ETFs offer investors a quick and easy method to buy a basket of foreign stocks. The options offered are numerous -- stocks in developed markets, stocks in emerging markets, growth stocks, value stocks, dividend-paying stocks, etc. And if the dollar falls relative to the currencies a fund's holdings are in, the prices of these holdings will rise, thereby protecting your purchasing power.

If an investor wants to buy foreign stocks directly, they can purchase either the actual foreign shares of companies or their ADRs -- American depositary receipts. Some major foreign companies offer ADRs, which trade on U.S. stock exchanges, as an easy way for American investors to buy their shares without engaging in cross-border transactions. A complete list of ADRs traded in the U.S. can be found at the Bank of New York Mellon website – www.adrbny.com. Even though the ADRs trade in U.S. Dollars, they will also rise and fall in value based on the exchange rate between the dollar and the stock's home currency. If the dollar falls, U.S. investors will see a rise in ADR share price.

Investors can also buy foreign shares directly in the company's home market. This is where investors can really see the effects currency exchange can have on their investment. Let's say you buy 100 shares of Company XYZ on the Tokyo Stock Exchange for 5,000 yen per share.

If the exchange rate at the time of purchase is 100 yen to $1, your investment costs $5,000. Say you hold this stock for one year, during which the dollar falls to an exchange rate of 80 yen to $1. Even if the share price stayed absolutely flat, your investment is now worth $6,250 in dollar terms -- a gain of +25% from currency exchange alone!

As you can see, you have several simple options you can use to profit from a falling dollar. But it's important to remember that the price appreciation of your investment (aside from currency exchange) can have just as much impact on your returns.