During the debt ceiling drama in Washington last month, and after the ensuing downgrade of U.S. Treasury debt by Standard & Poor's, most investors focused on the potential impact the moves would have on Treasury bonds and on the stock market. Yet largely forgotten in the turmoil was an issue that could have a much larger impact on both your investments and your personal finances for decades to come: the viability of the U.S. dollar as the world's leading reserve currency.
It's natural for most people to believe that the only time currency markets really have an impact on them is when they travel abroad. But over the long haul, continuing dollar depreciation could spell disaster for your financial survival.
Fortunately, financial innovation has made it much easier for you to protect yourself from this trend.
Are You Overexposed to U.S. Dollars?
Most people in the U.S. have huge exposure to the value of the U.S. dollar. Think about it: Workers get paid in dollars. Retirees get Social Security and pension benefits in dollars. Most bonds and stocks pay out investment income in dollars. Many people will go their whole lives without seeing a euro, yen, or peso.
But many of the things that we rely on in our everyday lives come from foreign countries, and as a consequence, currency exchange rates have a big impact on our costs. Moreover, when you combine exchange rates with lower labor costs abroad, you can tie the currency markets to outsourcing trends and the resulting loss of U.S. jobs.
As the overall economy gets more global, it makes sense for you to get more global in your personal portfolio as well. One way to do that is to reduce your exposure to the fate of the U.S. dollar by diversifying into other currencies. There are several ways to go about doing that.
1. Grab-and-go currency exchange
The obvious way to get foreign currency exposure is to go buy some. But shopping for foreign cash right next door to the duty-free shop is an expensive way to go. For one thing, most banks and currency exchange stores either charge big fees to trade your money or don't give you the best rates for your money. You can do better at a foreign ATM -- but that means you have to actually go abroad to get it.
In addition, once you have the cash in hand, you have to take steps to protect it. And worst of all, that cash won't earn you any interest. So while it gets points for simplicity, filling a briefcase with Brazilian reais or Swiss francs isn't the best solution.
2. Foreign currency bank accounts
A better alternative is to open a bank account in foreign currency. You can go directly to a foreign bank, but if you do, be prepared to run a gauntlet of questions and scrutiny. Dealing with two countries' regulations on banking can seem like an insurmountable obstacle course unless you find a banker who really wants your business. Unless you have substantial assets, the hassle may not be worth it.
A simpler solution is to use U.S. banks that offer foreign currency investments. For instance, Everbank offers WorldCurrency savings accounts and CDs in a variety of currencies that pay interest based on prevailing rates in the countries in question. The downside is that Everbank uses foreign exchange rates that include a spread that is typically within 1% of the market rate, meaning that if you convert back and forth as CDs mature, fees could add up. In addition, interest rates are sometimes far less than what you'd get from a foreign bank.
3. Currency ETFs.
A relatively new vehicle is the currency-tracking exchange-traded fund. You can find CurrencyShares ETFs in a variety of foreign currencies, where each share represents a fixed amount of the currency in question. These trade like stocks during the trading day and tend to move in lockstep with the forex market. With modest fees and the availability of interest for some currencies, currency ETFs can be a simple way to diversify your portfolio.
Give Your Money a Trip
Of course, putting all your money into foreign currency is just as risky as keeping everything in U.S. dollars -- and a whole lot less convenient, too, as long as you don't plan to leave the country and live abroad yourself. But having some cash cushion against a U.S. dollar disaster is worth considering, especially if you have enough saved up to justify the extra effort involved.
Motley Fool contributor Dan Caplinger loves collecting colorful foreign banknotes. You can follow him on Twitter here.