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Protecting Yourself from the Falling Dollar

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By ChrisBern
November 20, 2009

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I'm of the firm belief that in the next 5-10-15 years, the dollar will continue its current depreciation relative to other currencies. I'm also a believer that money can be made off of any economic situation, whether it's considered "good" (e.g. going long on a company that is doing well) or "bad" (e.g. going short on a company that is doing poorly).

So when I became convinced that the dollar will be slowly falling over the next several years, I felt compelled to re-evaluate my entire portfolio. Yes, I had some stocks which were "foreign" stocks, e.g. ADRs listed on the NYSE. But I had two fundamental concerns with my overall portfolio, (1) the vast majority of my stocks were American companies and (2) 100% of my portfolio was denominated in the U.S. Dollar (USD).

So I fixed both of these issues about 6 months ago. Now, only ~20% of my portfolio is denominated in USD, and the other 80% of it is roughly split between the AUD, JPY, EUR, SEK and CAD. This move alone has saved me 10% or more in depreciation losses that the USD has seen just in the last 6 months. But most importantly for the long-term, I am now diversified in several currencies so that if one particular currency (e.g. USD) goes into a free fall, my entire portfolio will not sink alongside it.

This transition required switching most of my holdings to Interactive Brokers, because I couldn't trade sufficiently well in foreign markets with TD Ameritrade or E*TRADE, which were my two brokers at the time. The transition also required that I buy stocks or ETFs on those foreign exchanges--after all, I didn't want to just buy foreign currency and have it sit there in cash. So to invest those foreign currencies in equities, I bought (mostly ETF) equities on those respective foreign exchanges. It took some time to figure this all out, but now I feel that I'm well diversified across multiple currencies and across multiple economies (the former being much more important than the latter, as the latter is less critical due to the high correlation of markets in the major world economies).

My question is, I haven't run into too many other U.S. investors who have actually gone to these lengths to diversify away from the USD. I read a lot of fool.com articles, and when they talk about the falling dollar and what a Fool can do about it, the discussion usually ends up talking about Global Gains and investing in NYSE stocks of companies that do a lot of business overseas. OK, that helps, but in that situation, the investment itself is still denominated in USD!! And that's the kicker...if the USD falls 20% in a year (which it may very well do in 2009), then your entire portfolio will be 20% lower relative to a non-USD portfolio, other things equal. And that is a MAJOR risk that it seems that there hasn't been enough attention drawn to. Your hand-picked portfolio of Global Gains or random stocks could beat the S&P 500 by 5%, but if the USD falls by 15%, you're still significantly worse off than a foreign investor whose currency is in something other than the USD, even if that foreign investor has put his entire basket in an S&P 500 ETF that is sold on a foreign exchange (and they do exist). i.e. if you believe in the American economy but not the U.S. dollar, you can still invest that way.

So what am I missing or why don't I hear others talking about similar strategies? Assuming that the USD is indeed going to continue to decline, which again I am personally convinced of, is there a hole in my thinking that currency diversification is absolutely essential? What are others doing to protect themselves from a falling dollar? I would love to hear an exchange of ideas on this topic...thanks in advance!