How to Invest in a Weakening Dollar
If you've done some traveling, you may have noticed that one year a dollar can buy .75 Euros and another year it can buy 1.25 Euros. You may also have wondered if you bought 1.25 Euros when the dollar was strong, could you make money by selling them when the dollar is weaker? The answer is yes.
or: How to Make Money When China Crushes US
If you're afraid that China's economy is going to destroy the U.S., then you could buy China's currency now. When the dollar collapses and the world is run by China, you can sell the Chinese currency for a bunch of U.S. dollars. Of course, if the U.S. dollar has collapsed, I'm not sure why you want so much of it. Toilet paper?
The joking example aside, there are investors who earn profits by tracking currencies and buy foreign currency when the prices are low, and sell the currencies when the prices are high. When they do this, they use their home currency to buy a foreign currency [e.g. U.S. dollars (USD) to buy Euros (EUR)]. Basically, they are trading one currency for another, or currency trading.
Trading Dollars and Euros
As of this writing the USD/EUR ratio is 1/0.88. This mean for every dollar you spend, you would get 0.88 Euros. If you invested $100, that would buy you 88 Euros. Now you have 88 Euros. Now you wait. If the USD strengthens, it will be worth more than it was before. Let's say the ratio increases to 1/0.5. Now for every dollar you spend, you would get half a Euro. But remember, you have 88 Euros. You could also sell each Euro for two dollars, equaling $176. In our example, you've earned $76. You've also seen an unlikely jump in the value of USD, so don't count on returns like that.
Of course, the USD doesn't always strengthen; what if it weakens? If the USD/EUR ratio becomes 1/1, then you would get one USD for every EUR you exchanged. Your 88 Euros are now only worth $88. This is at the core of currency trading risks.
Six Ways to Invest in Foreign Currencies
Direct Trading thru FOREX
The foreign exchange market, or Forex market, is similar to the stock market, only instead of trading money for stocks, you trade one currency for another in what are called currency pairs. (The USD/EUR from above is a currency pair). Just like a seedy liquor market, the Forex market is a 24-hour market, which is convenient for trading currencies in differing time zones. That also means just like a seedy liquor market, investors have the opportunity to make very bad decisions at 3 a.m.
Foreign Currency Mutual Funds
Just like every other asset class, you can invest in foreign currency in a diversified way through a funds strategy. Although they are not technically mutual funds, Exchange-traded funds (ETF) and exchange-traded notes (ETN) act very similar to them in that they pool your investment with others, and then the fund invests in foreign currency.
You can also choose between single currency funds and funds that invest in a wide range of currencies. If you believe that South American currency in general will increase in value, you can also invest in a fund which has a strategy to invest in South American currencies. The ETF and ETN strategy provides much more flexibility and diversity than buying currency directly, but it comes with its own costs so research the expense ratio.
You can also invest in foreign currency by buying bonds issued by foreign governments or bond funds that invest in foreign government bonds. When Chile issues a bond, it generally won't issue it in USD; Chile would issues the bond in their own currency. As a result, if you purchase a bond issued by the Chilean government, if the Chilean peso increases in value, then your bond will buy more USD. Investing in foreign bonds also has a side benefit of the interest you can earn from the bond while you are waiting for the country's currency to strengthen. Or, the consolation of earning interest from the bond while you watch the currency weaken and your money dissapear
Similar to foreign currency ETFs, international bond funds can invest in bonds issued by a single government while others invest in a region of the world. Many bond funds also invest internationally, but focused on developed countries, emerging countries, or under-developed countries.
Foreign Bank CDs
You can also use USD to purchase certificates of deposit (CDs) in foreign currencies. These have similar benefits to bonds, but may come with additional protections to consumers. That lowered risk will also likely come with a lowered interest rate.
Foreign Currency Futures & Options
If you want to add a little more cost and speculation to your currency trading, you can also trade in futures and options. Futures and options are contracts that allow investors to either buy or sell a currency at a specified date at a specified price. With futures, the investor is obligated to buy the currency at the specified date for the specified trade ratio. With options, investors have a choice. Using these contracts, if you lock in a price of 1/0.88 for buying Euros, if the dollar strengthens you have the ability to buy .88 Euros and immediately sell them for a profit.
If the dollar weakens, you would lose the money when the futures contract comes due. With the options contract, though, you would just choose not to exercise the contract. So why would anyone choose futures? For the same reason why you probably shouldn't use futures and options. There is a cost for entering into these contracts, and the cost is more for options than for futures. Adding an additional cost onto a speculative investment is generally not a formula for winning. Furthermore, the fact that the contract specifies a date also increases the risk because you not only have to be right about the dollar strengthening, but you also have to be right about the timing.
Before you invest in foreign currencies, make sure that you understand how to research the foreign currency market. Like all types of investing, this carries risk. You should understand how to choose your investments and manage the risk before committing your hard-earned money.
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