Vacation in Europe this summer and you’ll be shocked at what things cost. Today a dollar is worth about 0.74 euros, down sharply from about 1 euro four years ago. The fall has virtually unbroken since early 2006. In fact, the dollar has been losing value against many major currencies since early in the decade.
Most experts blame the U.S. trade and budget deficits, which cause Americans to send dollars overseas, increasing the amount of money in circulation that drives down the price.
The rate at which one currency is exchanged for another is governed by supply and demand in the 24/7 global currency markets, where an estimated $3 trillion changes hands every day through forwards, futures, spot trades and other transactions.
Can the small investor play this game?
Yes. There are a number of ways to profit, directly and indirectly, from shifting exchange rates. You could make money on a falling dollar — or a rising one. Or you could bet on some other currency. But it takes a strong stomach.
With as little as $200 to $250, you can open an online foreign-exchange account (also known as forex) to speculate the same way banks do, with futures contracts. These allow you to exchange one currency for another at a set rate on a given date. You might for example, sell dollars and buy euros. If the dollar falls, you’d use those euros to buy dollars later, ending up with more dollars than you started with.
One of the big firms offering small-investor accounts is Global Forex Trading. Others include Forex.com, Capital Market Services and FX Solutions.
Here's some advice if you want to try this:
- First, don’t bet more than you can afford to lose. Currency markets are fickle and fast-moving, and you’ll be up against pros who do this all day every day. Because every futures contract expires on a set date, you cannot simply wait out a downturn as you can with stocks or mutual funds. You have to monitor your positions closely so you can decide when to close them.
- Second, don’t start out with a lot of leverage. Many firms will allow trader to borrow the bulk of the money they bet. They may, for example, require that you deposit only 1/400th of the amount you put at risk. That means your potential losses are far greater than the amount you put into the account.
If this is daunting, another option is to get a professional manager to do the work. Some require an initial deposit as low as $10,000, although $100,000 minimum is more common. Typically, the manager takes 25 percent of the profits earned in your account, plus an annual fee equal to 2 percent of your assets.
Managers can be found by typing “forex money manager” into your search engine. But it’s much better to get a referral from someone you trust. Ask your stock broker or financial advisor. Before signing with anyone, do a background check through the National Futures Association’s BASIC service.
For another approach, look at the handful of mutual funds and exchange-traded funds specializing in currencies.
The best-known mutual fund is the Franklin Templeton Hard Currency Fund (ICPHX) which invests in foreign money-market accounts and forward contracts, which are like customized futures contracts. Annual returns have averaged about 9 percent over the past five years. Research it at Morningstar.com, and note the rather steep fees — a 2.25 percent load, or sales charge, and 1.13 percent annual expense ratio.
For an alternative, look at the Merk Hard currency fund (MERKX), a no-load fund that gains when the dollar falls.
Also consider Rydex Investments’ Strengthening Dollar and Weakening Dollar Funds. These are for active traders who shift money from one fund to the other to bet on the dollar’s ups and downs.
The newest entries into the small-investor currency field are a handful of exchange-traded funds, which are similar to mutual funds but trade like stocks. Rydex has eight CurrencyShares ETFs specializing in different currencies. ProFunds Advisors has similar funds for betting on a rising or falling dollar.
By now you should have a clear picture: Currency speculation is fast-paced and risky. Isn’t there an easier way?
There is — investing in mutual funds that own foreign stocks. When you invest, your dollars are converted to euros, yen or other currency, which is then used to buy foreign stocks. The process is reversed when you redeem your shares. Stocks are sold, generating foreign currency which is then exchanged for dollars.
So, if the dollar falls after you invest, you can enjoy two types of gains — from the falling dollar and any increase in the share prices of the stocks in the fund. The weakening dollar has contributed to the stunning gains Americans have enjoyed in foreign-stock funds in recent years.
Of course, it works the other way, too. If you invest in a foreign-stock fund and the dollar then rises, you could lose money on the fund even if its stocks do well.