In the aftermath of the financial crisis, many people believed that the government's responses set the stage for a coming dollar disaster. After receiving a last-minute stay of execution in the form of the European sovereign debt crisis, the U.S. dollar now seems to be resuming its downward spiral. If you earn a salary in dollars and have most of your savings in dollars, you need to consider just how exposed you are to a potentially permanent loss of value in your assets -- and what you can do to protect yourself from that risk.
Compared to the currency crisis from a couple of years ago, the dollar's plunge this time around is largely under the radar. That's because when you compare the dollar to the euro, the greenback is still a lot stronger than its record lows.
But exchange rates with other trading partners have reached alarming levels. The Swiss franc set an all-time high earlier this year and now trades well above parity, meaning that it takes more than a dollar to buy a single franc. Backed by a commodity-rich economy, the Australian dollar also traded above its U.S. counterpart recently at multidecade highs, and the Canadian dollar was worth just a hair under a buck as of yesterday.
With QE2 yet to take hold, few expect the dollar to rebound substantially in the near future. If you think the trend toward a weaker dollar will continue, then here are some ways you can turn dollar weakness into profits that will protect your portfolio.
1. Foreign stocks
One of the most obvious ways you can position yourself to benefit from a falling dollar is by owning foreign investments. As the dollar drops, the value in dollars of a foreign investment goes up, even if its share price in local currency terms stays constant.
The broad-market foreign ETF iShares MSCI EAFE Index
2. Foreign bonds
An alternative to stocks for conservative investors is to buy bonds denominated in foreign currencies. In addition to the beneficial currency effect, another advantage to foreign bonds is that they pay more interest than U.S. bonds paying rock-bottom rates.
Funds are your best bet for foreign bonds. Closed-end funds like Aberdeen Asia-Pacific Income
3. Direct currency bets
If you don't want investment risk at all, a pure currency play may be your best choice. But you don't have to go to the airport and change your green money for multicolored paper from around the world.
Currency ETFs now make it easy to pick a variety of foreign currencies. You can either pick specific currencies or buy a basket that includes money from several different countries. In some cases, you'll even get paid dividends based on prevailing local interest rates in that currency.
4. Precious metals
The one thing that foreign stocks, bonds, and currencies don't take into account is the possibility of a concerted failure of fiat currencies around the globe. If you think there's nothing inherently better about the euro, yen, or renminbi than the U.S. dollar, then you may want to retreat to the historical money of last resort: gold.
Whether funds SPDR Gold Trust
5. U.S. stocks
This last category may seem misplaced. But just as some foreign stocks are highly dependent on the U.S. economy, so too are many U.S.-based stocks well-positioned within the global economy. Coca-Cola
Of course, many see the idea of a downward spiral in the dollar to be completely ludicrous. Yet even without a total collapse, diversifying your portfolio to give yourself some non-dollar exposure matches can reduce your overall risk. As policymakers continue to move into uncharted territory, risk management is more important than ever.
ETFs can help you protect yourself from the dollar's declines. To learn about some great ETFs that belong in your portfolio, including an international ETF, click here to get The Motley Fool's free report, 3 ETFs Set to Soar During the Recovery.
Fool contributor Dan Caplinger collects foreign currency. He owns shares of iShares MSCI EAFE Index ETF. Coca-Cola is a Motley Fool Inside Value selection and a Motley Fool Income Investor choice. The Fool owns shares of Coca-Cola and Teva Pharmaceutical. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't die on you.