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Diversify Your Cash With New Currency ETFs

One of the first elements of portfolio construction is the allocation of capital between stocks, bonds and cash. I believe the cash part of that equation is about to undergo some serious evolution in the coming weeks, thanks to some innovations from the folks at Rydex Investments.

Last December, Rydex listed the Euro Currency Trust (FXE). Each share of the Euro Currency Trust equals 100 euros. As early as next week, Rydex will list six more currency ETFs, covering the British pound, Australian dollar, Canadian dollar (the Loonie), Mexican peso, Swedish krona and Swiss franc.

Accessing the foreign exchange market has been difficult and imprecise for individual investors, but these new ETFs make it much easier.

There are many reasons the dollar could weaken over the next few years: The U.S. has large and growing current account and budget deficits; there could be less demand for U.S. dollars as various countries consider diversifying their currency reserves; and there is the possibility that certain commodities could trade in euros as well as in U.S. dollars.

These concerns guarantee nothing about the future direction of the dollar, but they do suggest a weaker dollar. A weak dollar is easily hedged in an equity portfolio with foreign stocks and in a bond portfolio with foreign bonds (more like a foreign bond fund), but what about the cash portion of a diversified portfolio?

If you are willing to put a portion of your equity portfolio in foreign stocks, why not put a portion of your cash in foreign currencies? That's where I believe the new currency ETFs can come into play.

If you have never thought about investing in currencies, your initial reaction might be that they are too risky. But like any investment product, currencies can be risky or conservative; it depends on how they are used.
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