By Heidi Foster
Reducing risk while increasing the potential for return on one’s investment is the goal of every investor and investment adviser. The process is part art and part science. While the art of this process is difficult to explain, the science can be simplified into increasing the diversification of the investments and reducing their correlation.
When most individuals are building their investments, they primarily invest in equity (stock) and fixed income (bond) markets. Investors tend to avoid the most liquid of all markets, currency markets. While investing in currency is often thought to be rather risky, the associated risk might not be much higher than investments in equity if managed.
Returns on currency investments include the potential yield, as well as the appreciation or depreciation of one currency against another. The value of a currency is influenced by many factors, including the associated GDP, debt, balance of trade and interest rates, as well as what role fear is playing in the global economy and the stability or lack thereof the corresponding government.
In recent years, many types of investments that had previously only been accessible to the extremely wealthy or institutions have become available to ordinary investors through exchange trades funds (ETFs) and mutual funds. These relatively newly available markets include commodities, futures and currencies, to name a few.
While investors do gain some exposure to currency markets through foreign bonds or stocks, these investments are becoming increasingly correlated to domestic investments of the same. However, investing directly in foreign currency lacks correlation to either of the traditional investing markets. Currency investments have shown a correlation to commodities and to inflation and thus could potentially be beneficial as an inflation hedge.
Investing in currency is still not a simple process.
While currency mutual funds, ETFs and exchange traded notes, ETNs, do exist, they are generally limited to being paired against the U.S. dollar and might not offer investors the flexibility and control they desire. To gain flexibility and control, investments in currencies are often made through time deposits with a prevailing interest rate applied to the investment, options or forwards.
When investing in currencies, markets tend to move in trends but can change direction quickly. As a result, investors generally look to invest for a week to no more than three months at a time. Since currency investments tend to be short and highly liquid, they might be used as a way for investors to diversify investments in cash. With many investors shortening duration of their fixed-income investments, currency investments might play a role in reducing risk to investment portfolios.
Investing in currencies can be tricky.
Investors should first study them and also find a good adviser with whom to work. If you think that investing in currencies might be beneficial, please discuss the options with your financial adviser.
Heidi Foster, wealth adviser and investment manager with American Wealth Management, can be reached at www.financialhealth.com, 775-332-7000 or firstname.lastname@example.org. Securities offered through Foothill Securities Inc., member FINRA/SIPC. Investment advice offered through American Wealth Management, a registered investment adviser and a separate entity from Foothill Securities Inc