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It seems
simple enough: If investors are souring on the dollar
and gravitating to other currencies, why not follow
along?
But
deciding to move money beyond the greenback is easier
than figuring out where to go.
Investors
can buy foreign bonds;
FDIC
-insured certificates of deposit denominated in a
currency such as the Australian dollar or Brazilian
real; a mutual fund or exchange-traded fund that invests
in a single foreign currency or a variety of them; or
funds that use leverage to magnify a gain or loss on a
currency bet.
But,
experts warn, even sophisticated analysts are humbled by
changes that can send a currency on an unexpected course
virtually overnight. Look no further than the Brazilian
real, which has been soaring and attracting foreign
investors. It gained about 35 percent against the U.S.
dollar this year.
But to
tame some of the frenzy,
Brazil's
financial authority announced last week a tax on foreign
investment in local bonds and stocks. In response, the
currency dropped almost 4 percent in a day.
Currency
values can be affected by many factors, so focusing on a
single country is considered risky.
Last
year, for example, the U.S. dollar fell sharply in the
spring and rallied strongly later in the year as
investors worldwide, concerned about the financial
crisis, wanted their money in the greenback. Now,
investors are shifting money away from the dollar for
reasons including fear over U.S. deficit spending and a
desire to receive higher interest from other countries.
An
investor might earn about 1 percent on a three-month
U.S. CD, for example, but recently they could put money
in a CD involving the Brazilian real and make 4.58
percent interest through EverBank, an Internet bank that
allows transactions such as a
$10,000
-minimum foreign CD investment.
For
investors with a longer time frame and a
$20,000
to invest, there's a three-year Brazilian Supra National
bond issued by the
World Bank
that's paying about 9 percent, said
Chris Gaffney
, vice president of world markets for EverBank.
On the
face of it, going for the higher yield seems like a
no-brainer, because the U.S. CD and the Brazilian CDs
sold by EverBank are
FDIC
-insured. And the World Bank Brazilian real bonds are
rated AAA, Gaffney said.
But
investing in a foreign currency is not the same as
buying a U.S. bond or CD. The money you invest may be
safe, but that doesn't mean you will receive back every
penny you invested.
That's
because anything you put in will be converted back into
dollars when the investment matures. So if the dollar
continues to weaken compared to the CD or bond currency,
you will make more money than you invested. But if the
dollar strengthens, you could pocket less than you put
in.
Say, for
example, that at the beginning of 2008, you invested in
a Brazilian bond that paid 9 percent and matured at the
end of the year. In 2008, the real lost 23 percent
compared with the dollar as investors feared emerging
markets would be hurt badly in the global economic
weakness.
Because
of that drop, you would have had a loss at maturity of
14 percent, Gaffney said.
To avoid
such risk, financial advisers often tell clients not to
make a single currency bet, though they can through ETFs
such as the
Rydex CurrencyShares Australian Dollar Trust
(FXA) and the
WisdomTree Chinese Yuan Fund
(CYB).
Investors
also can bet that the dollar will rise compared to an
index of other currencies by buying the ProFunds Rising
U.S. Dollar fund (RDPIX), or they can bet that the
dollar will fall with the ProFunds Falling U.S. Dollar
fund (FDPIX).
But
financial advisers often suggest people invest a small
portion of their bond portfolios in an array of
currencies selected by a professional experienced in the
currency market. Among funds with high
Morningstar
ratings are the Pimco Foreign Bond (PFBDX) and the T.
Rowe Price International Bond (RPIBX).
The
temptation to bet against the dollar or for a single
currency might be great now, says
Morningstar
analyst
David Kathman
. "But that kind of thinking is potentially
dangerous."
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