Knowing what currency ETFs are about, why you should consider them, and what impacts their performance can help you decide how to incorporate them into your investment strategy.
Currency ETFs (exchange-traded funds) may track a single currency or a basket of currencies.
The simplest currency ETFs are backed by bank deposits in a foreign currency. However, there are also more complex currency ETFs that purchase currency derivatives (primarily forward and swap contracts, which are agreements to exchange an asset at a predetermined date) to achieve foreign currency exposure.
Depending on the types of assets already in your portfolio, having non-dollar currency exposure may provide additional diversification. Some investors may also use currency ETFs to hedge non-dollar liabilities or to speculate on exchange rates.
What are the pros and cons of currency ETFs?
The currency market used to be available only to institutional investors and macro hedge funds. Now, with ETFs, the currency market for many popular currencies is open to any investor. To help you find out whether currency ETFs are right for your portfolio, it’s important to examine some of the benefits and risks.
The diversification of your portfolio may be enhanced by having non-dollar investments.
Impact of outside influences
Currency ETFs are affected by interest rates, geopolitical decisions, and other economic factors. Any negative change within these areas could potentially cause currency ETFs to decline in value.
As mentioned above, currencies are impacted by outside factors that can present risks. However, identifying some common outside factors and being aware of them when analyzing the market and making decisions can help you with your strategy for using currency ETFs in your portfolio.
A variety of factors could impact the value of currencies, including:
- Interest rates
- Economic events
- International trade
- Political decisions
- Global conflicts
- Natural disasters
- Intervention by central banks
If you are considering investing in currency ETFs, following global news, tracking global trends, and researching analyst data can help you know where to invest.
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