Would your planning still be as viable and valuable?"

Some professionals regard these questions as rhetorical – like asking about angels dancing on pins.

Others believe the dollar's value is just the inverse of inflation, and modest inflation is a fact-of-life that can be factored into planning assumptions.

But others – a select few – get it. They see that a sustained decline in the dollar could have serious repercussions for their clients' planning. They also can separate concepts of planning for normal inflation from the different issues involved in planning for currency devaluation.

At the top of the profession, a few practitioners are building currency management into their processes and portfolios. In this article, I'll review ideas you can implement in 2011.

Weak Dollar: Past vs. Future

The U.S. dollar reached its peak as a measure of global value in February of 1985, when the Trade Weighted Exchange Index vs. Major Currencies (TWEMX) hit 146. Through the end of 2010, the TWEMX had declined by 49% (to 73). Against the true "hard currencies" – gold and crude oil – the dollar declined by 68% and 78%, respectively, over the same 25-year period.

The Deficit and the Fed – Perhaps the most important change in the U.S. dollar's value looking forward is the soaring federal budget deficit combined with a change in the role of the Federal Reserve. The $2.7 trillion two-year combined federal deficit for fiscal 2009 and 2010 exceeded the cumulative deficit from 1985 through 2003 ($2.4 trillion). Since the Fed launched its quantitative easing (QE) program to monetize the U.S. debt, it has become the largest holder of U.S. Treasuries – ahead of China and Japan.

QE represents the most aggressive monetary policy ever undertaken by a Central Bank in history. To get the economy moving, the Fed believed it needed to throw sticks of dynamite in a stagnant pond. Over the short-term, the pond has begun to flow, but the long-term impacts on the flora and fauna may be severe. In this case, the "flora and fauna" were entities all over the world that still had confidence in the dollar, until QE2.

In summary, a majority of the world's twenty largest economies (G20 nations) have taking steps to keep their currencies from appreciating. But the forces behind the dollar's decline aren't temporary manipulations. They are long-term, structural, and accelerating. Several factors that have cushioned American household finances against dollar depreciation in the past can't be counted on going forward.

It's time to let clients know that: 1) Long-term planning denominated in dollars may not help to maintain lifestyles or achieve goals; and 2) Building an "inflation factor" into planning assumptions may not protect against a weaker dollar in the future, as it has in the past.

Six Ideas for Currency Management

1. Diversify Portfolios Internationally – A simple way to help your clients hedge dollar risk is to increase the international exposure of portfolios, while avoid mutual funds that attempt to hedge foreign currency risk.

For example, suppose a client invests $50,000 in an ETF that tracks the MSCI EAFE Index. This investment represents exposure to foreign stocks of 22 countries abroad. But it also creates $50,000 of exposure to 12 foreign currencies – with the heaviest weights to euros, U.K. pounds, and Japanese yen. When the dollar is weak, unhedged foreign currency exposures will convert into a positive component of total return.

In effect, the investor goes "short the dollar" and "long the foreign currency" for as long as the international investment is held. The table below compares gross (total) returns of the MSCI EAFE over 1-year, 5-year and 10-year periods.

Comparison of MSCI EAFE Gross Returns

Source: MSCI for periods ending 12/31/10.

For example, over the past 10 years, EAFE has returned 0.60% annually in local currency. But for a U.S. dollar investor, it has returned 3.94%. So, about 85% of EAFE's total return over a decade has been driven by currency gains, not stock performance. In 2010, the MSCI Emerging and Frontier Markets Index returned 19.38% for U.S. dollar investors, but only 14.74% in local currency.

You can help your clients see the impact of currency gains/losses on international investments at MSCI's performance data base here:

http://www.mscibarra.com/products/indices/global_equity_indices/performance.html

In fixed income, a new ETF for participating in a mixed basket of emerging market bonds (and attached currencies) is Market Vectors EM Local Currency Bond ETF (EMLC) from Van Eck.

2. Single Foreign Currency ETFs – Currency ETFs offer a convenient way to participate in individual foreign currencies. For example, suppose the investor in the example above wanted to purchase $50,000 of exposure to the EAFE currencies, and also wanted to add some Canadian dollar exposure (which is not included in EAFE). Implementing this idea is as simple as buying the Rydex CurrencyShares Canadian Dollar Trust (FXC). Each dollar invested in this ETF creates an additional dollar of exposure to a single currency.

Rydex led the launch of single-currency ETFs in 2005 and 2006, and these vehicles have proven to be efficient tools for adding exposure to individual currencies. Because they are implemented with the internal leverage of futures (and keep most assets in interest-bearing cash), the ETFs earn an increment of cash return that offsets fund fees and expenses. Tracking with the underlying currency is tight and slippage is minimal. The table below summarizes performance of leading CurrencyShares ETFs.

Performance is as of 12/31/10, based on market price.

These ETFs can be used to diversify cash held in a brokerage account among several currencies. For example: In 2010, putting money into Canadian currency (FXC) would have been equivalent to earnings 4.96% on brokerage account cash held in dollars.

In general, currency values tend to be somewhat mean-reverting. So, it can be a good strategy to take gains exceeding a threshold (such as 5% or 10%) "off the table" and then wait for a pullback. Also, it helps to know the point at which foreign governments feel compelled to intervene and "put a lid" on currency appreciation vs. the dollar. For Canada, that point seems to be at about "parity" – i.e., when one Canadian dollar equals one U.S. dollar.

Perhaps the single best foreign currency for long-term buy-and-hold purposes is the Swiss franc, mainly because it isn't heavily manipulated.

For emerging market currency exposure, Wisdom Tree offers ETFs for China (CNY), Brazil (BRL) and India (INR) and South Africa (SZR), and Rydex covers Russia (XRU).

3. Currency Basket ETFs – For clients who want to buy one ETF that holds a diversified basket of foreign currencies, you can use PowerShares DB US Dollar Index Bearish Fund (UDN) to participate in the developed market currencies. Similarly, you can use Wisdom Tree Dreyfus Emerging Currency Fund (CEW) to participate in a basket of emerging market currencies.

4. Currency Strategies and Funds – All of the currency instruments described above go "short the dollar" and "long foreign currency." But the dollar isn't the only weak currency in the world, and the dollar can strengthen over intervals. To participate in multiple paired currency trades driven dynamically by quantitative models, several choices are available. They include:

• Merk Absolute Return Currency Fund (MABFX) – This mutual fund is an interesting choice for implementing a "currency asset class" in an asset allocated portfolio. The fund holds a variety of foreign currency in pairs (long or short) with the U.S. dollar. The net exposure vs. the dollar (long or short) is driven by quantitative factors such as valuation, momentum, carry and resources. With a 9/9/09 inception, the fund returned 4.65% in 2010, according to Morningstar. Its drawbacks include minimal assets ($22 million as of 1/3/10) and a high expense ratio of 1.30%.

• PowerShares DB G10 Currency Harvest Fund (DBV) – This ETF, launched on 9/18/06, implements a "carry" strategy by choosing three long-short currency pairs among the G10 (developed nation) currencies. The three highest yield currencies are held long and the three lowest yield currencies are held short, with quarterly rebalancing of components. The carry strategy has been described as "picking up dimes in front of a steam roller," because it generates modest increments of positive returns until a "reversal event" occurs during a period of risk-aversion, at which point carry trades unwind. Such a reversal battered DBV in 2008, when it declined by 27.81%. But in other years, the strategy has been generally rewarding.

• Deutsche Bank (DB) Currency Indexes – Deutsche Bank is emerging as the global leader in developing innovative model-driven multi-currency indexes. In 2011, financial professionals should stay abreast of developments which may make some of these indexes investable via ETFs, exchange-traded notes (ETNs) or actively managed funds. You can access information about DB currency indexes, including price levels and performance, at the firm's online index portal:

https://index.db.com/dbiqweb2/home.do?redirect=homepage

5. Income Payouts Denominated in Foreign Currencies – For all its diversity and sophistication, the U.S. annuity industry still does not offer products that guarantee payout in foreign currency or a basket of currencies. Subject to state availability, Lincoln National Life offers the SmartIncome Inflation annuity, a single premium immediate annuity (SPIA) with payout indexed to the CPI-U, and Penn Mutual offers Inflation Protector Variable Annuity, with the living benefit base and retirement withdrawals linked to the CPI-U.

The trendsetter for financial products with income payouts denominated in foreign currencies is EverBank, which offers CDs denominated in a variety of foreign currencies and also a basket of foreign currencies. For example, a one-year maturity Australian dollar CD currently is yielding 3.63% (APY). A basket mixed equally among Australian, Brazilian, Canadian and Norwegian currencies is yielding 2.52%. Although EverBank CDs are FDIC-insured, the insurance does not cover currency losses.

6. Ancient and modern hard currencies – Gold is the oldest currency in the world – the only currency that has been in continuous use, and universally accepted, over 4,000 years of human civilization. Day-to-day and year-to-year, gold will fluctuate significantly away from its "intrinsic currency value." But gold always returns to its historic role in human commerce – namely, as the currency against which all others (especially paper) are valued. In an age of dollar devaluation and previously unimagined Fed money-printing, every portfolio should own some gold (or another precious metal), in some form.

The largest precious metals ETFs, SPDR Gold Shares (GLD) and iShares Silver Trust (SLV), have reliably tracked the price of gold and silver bullion (less accumulated expenses) since inception on 11/12/04 and 4/21/06, respectively. Over six years, GLD has averaged a return of just over 20% per year while accumulating gold holdings totaling $57 billion. There is every reason to think gold (in any form) will continue to perform well in the years ahead, as the dollar keeps sinking.

In general, financial advisors should focus less on whether gold is over- or undervalued and focus more on the direction of the dollar. Over time, gold's price is the best measure of the rate of dollar decline – in the inverse.

An equally viable strategy is to offer clients exposure to commodities that could soar in price if the dollar plummets. For example, suppose your client owns a business that uses 5,000 gallons of gasoline per year. How can you buy 5,000 gallons worth of a gasoline hedge strategy? Purchase 500 shares (approximately $16,000) worth of the United States Gasoline Fund ETF (UGA).

Two other energy ETF alternatives are United States Oil (USO) for crude oil exposure and PowerShares Energy Fund (DBE) for mixed energy commodities. In an energy ETF, it's important to pay attention to the futures curve and avoid "contango" – i.e., sharply higher cost in more distant futures expirations. Contango creates a "negative roll yield" in futures-based ETFs. For most of 2008 and the first part of 2009, it worked against energy ETFs. But now, contango has become much less of a negative in gasoline and crude oil.

In summary, the surest bet in personal finance is that the dollar will lose value over the next decade. Of course, the dollar may appear to hold ground against other structurally weak currencies such as the euro and heavily manipulated currencies such as the yen.

But measured against the ancient currency of gold and the new global currency of oil, the dollar will drop. The only question is how much the decline will cost your clients in their standards of living.

You now have more tools to protect clients against dollar depreciation than ever – and even better currency management tools are on the way.