Conventional wisdom in creating a healthy, diversified portfolio needs to be updated to reflect new market opportunities. Small investors now, more than ever, have the opportunity to include what are historically institutional-only assets in their personal holdings.
The modern investor has a wealth of new tools to achieve real diversification. Small investors are encouraged to spread their portfolios across a range of stocks and bonds. Small caps, mid caps, large caps, value, growth, short and long-term Treasuries, and municipal bonds have been the staple of a diversified portfolio. Well, times have changed and so too should your notions of eggs and baskets.
Exchange-traded funds (ETF's) change the old notions of portfolio management. Individual investors can now add commodities (precious metals, corn, wheat, soy, cattle, oil, natural gas, etc.), currencies, and specific sectors of the economy just as easily as they can add stocks.
A great way for American investors to hedge inflation and the decline of the dollar is to purchase currency ETF's. These instruments enable investors to gain exposure to specific foreign currencies, which are often uncorrelated to US 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.
There are multiple consderations in portfolio theory, but applying the basics can have far reaching benefits. Those concerned with dividends should hold the highest yielding ETF's, which include British pound, Australian dollar, and Mexican peso. On the flip side, income investors should avoid Swiss Franc and Japanese Yen.
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.
About the Author:
Rob Viglione is an author, hedge fund manager, and real property broker and consultant. He writes about political and financial freedom on The Freedom Factory.
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