Currency investing may seem appealing but you’ll lose in the long run

It’s A Rare Investor Who Makes Enough Profit From Long-Term Currency Investing Activities To Compensate For The Risk Involved

As a general rule, we advise against long-term currency investing speculation for many of the same reasons we advise against options trading and bond trading. It’s a rare investor who makes enough profit from these activities to compensate for the risk involved.

Our view is that if you like a currency’s outlook, you should buy stocks that will profit from a rise in that currency. Our longstanding advice is to invest mainly in well-established companies. Avoid exposure to currency trading, penny stocks, new issues, options, futures or any high-risk investments. That way, while you may experience modest losses when markets drop, you should show overall positive results over time.

Keep hedged ETFs as a long-term currency investing strategy out of your portfolio

If you want to buy U.S. stocks and hedge against currency movements, you could buy a hedged ETF.

Hedged ETFs, like, say, the iShares Core S&P 500 ETF (symbol XUS on Toronto) are funds sold in Canada that hold U.S. stocks. However, they are hedged against any movement of the U.S. dollar against the Canadian dollar. That means that the ETF’s Canadian-dollar value rises and falls solely with the movements of the stocks in the portfolio.

For example, if a stock rises 10% on, say, New York, but also rises a further 5% for Canadian investors due to an increase in the U.S. dollar, a holder of a hedged ETF would only see a 10% rise in the value of that holding in their hedged ETF. At the same time, the reverse is also true: If a stock rises 10% on New York, but falls 5% for Canadian investors due to a decrease in the U.S. dollar, a holder of a hedged ETF would still only see a 10% rise in the value of that holding as part of their hedged ETF.

Note, though, that hedged funds include extra fees to pay for the hedging contracts needed to factor out currency movements. Of course, those costs can rise or fall regardless of currency swings.

Hedging against changes in the U.S. dollar only works in your favour when the value of the U.S. dollar drops in relation to the Canadian currency. If the U.S. dollar rises while your investment is hedged, it reduces any gain you’d otherwise enjoy, or expands a loss.

However, we see U.S.-dollar exposure as a long-term plus: a valuable form of diversification. If you are worried about the possibility of a U.S. dollar decline, our advice is to reduce your exposure to U.S. stocks and other U.S. dollar assets. There are no bargains in the market for foreign-currency hedges.

Overall, we don’t recommend hedged ETFs.

Exclude forex contracts as a long-term currency investing strategy to lower your risk of losing money

Forex investments are investments that deal in foreign currency futures or options trading.

Forex contracts can make a lot of sense for an operating business or individuals that are forced to take on currency risk based on their job, like a farmer or an import/export firm. These let businesses pass that risk on to speculators who wish to accept it.

However, investors need to be wary of advertisements on the Internet for forex investment systems and training courses. These courses fail to emphasize that most speculators who succumb to the lure of forex investments wind up losing money. It doesn’t matter if they trade foreign currency or a traditional commodity such as wheat. In the end, they almost always end up losing.

Here’s how things typically work out: Suppose an investor starts out with the intention of losing no more than, say, $15,000. After a few months of trading on futures in foreign-exchange investments, the investor will typically have broken even on his futures trading: if you ignore commissions. But if you count commissions, which obviously have to be paid, the investor will have lost most of the $15,000. In other words, the futures trades on forex securities work out like bets on a series of random events such as coin tosses. You’ll win a few and you’ll lose a few, but you won’t win enough to pay your commissions, let alone leave yourself with a profit.

Ignore the appeal of long-term currency investing, and instead use our three-part Successful Investor approach to make better stock selections

1. Invest mainly in well-established, dividend-paying companies, with a history of rising sales if not earnings and dividends.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities.
3. Downplay or avoid stocks in the broker/media limelight. When stocks spend time in the limelight, they tend to become overpriced, and this leaves them vulnerable to a sharp downturn on any hint of bad news. Instead, look for stocks with hidden value that are less widely recognized—at least so far—as attractive investments.

In what direction do you feel the U.S. dollar will move over the next few months or year?

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was originally published on July 12, 2019 and is republished on the Hub with permission.