Real Estate Innovation

Adding Currencies to Your Portfolio

Diversification is the best way to reduce portfolio risk. It has long been understood that spreading your capital wisely can save you from unexpected asset deterioration, but exactly how to do that needs to be reconsidered.

An industry has been built around smooth talking salesmen advising people to diversify their portfolios into a variety of stock and bond products. These well-dressed businessmen extol the benefits of such and such value or growth stock fund. They sound sophisticated when they tell you that small caps are countercyclical to large caps, and so forth. The reality is that stocks are stocks and regardless of how you splice up and segment them into categories, they hold inherently similar correlations.

It’s easier than ever to pick up the same kinds of exotic investments as the most sophisticated hedge fund in days of yore. Regular people can now include all types of commodities (from agricultural to energy and everything in between), currencies, and select stock sectors in their portfolios simply by purchasing exchange-traded funds (ETF’s).

Currencies, in particular, offer individuals a powerful alternative for hedging inflation and the decline of the US dollar, and adding a new level of diversification to offset adverse movements in stocks and bonds.

Portfolio theory suggests that adding minimally or negatively correlated assets to your portfolio can decrease overall portfolio variance, or risk.

For currencies, it is necessary to analyze how they move in relation to US stocks, bonds, and other assets that are held in traditional portfolios. Doing so indicates that Japanese Yen, Swedish Krona, and Swiss Franc move opposite to US stocks, while Canadian dollar, Australian dollar, and Mexican peso move with stocks. So if your portfolio holds US stocks you should consider the former currencies and exclude the latter.

Holding Swiss Franc, Euro, Yen, or Krona would have yielded roughly between 12% and 17% in capital appreciation over the last year. Not only that, but each ETF has a dividend yield, representative of interest rates within each country.

An income investor should consider holding Mexican Peso, Australian Dollar, and British Pound, while avoiding Yen and Swiss Franc. There are many factors to take into consideration, but applying basic portfolio theory to your own holdings can have signficant long term results.

Currencies offer another way for investors to lower their overall portfolio risks. By choosing negatively correlated currencies traditional portflolios comprised of stocks and bonds can achieve lower overall risks. Additionally, investors can protect against depreciation of their own currencies and gain exposure to higher interest rates offered on cash overseas.