- Created on Tuesday, 26 February 2013 00:00
- Published on Tuesday, 26 February 2013 07:00
- Written by Jim Nelson, Contributing Editor, Inside Investing Daily
- Hits: 927
Today, I want to introduce you to a new way to think about stock market investing that will boost your income yields, while limiting your risk.
In fact, without following this simple step you are unlikely to ever make truly lucrative income gains from stocks.
You see, every income investment you make is actually two bets: one in the stock or bond and one on the currency it is denominated in.
If you buy only U.S. stocks, every dollar you invest is also a bet on the U.S. dollar. And considering the threats facing the buck from unlimited Fed money printing, that's not a safe investment strategy. Especially given that most of your other assets are probably also denominated in U.S. dollars.
In the chart below, you can see the decline in buying power of the dollar since 1971, measured on the left axis. On the right is the amount of currency in circulation.
Let me give you a real world example of what I mean...
In January 2009, the global economy was reeling from the financial crisis. But that wasn't a good reason to flee stocks. Quite the contrary; smart investors were buying quality stocks "on sale."
The problem was finding what to buy...
A careful study of countries with the highest growth potential and the strictest fiscal policies led me to Brazil. The country had a fast-growing middle class, tough banking regulations and rising currency - the real.
I recommended a company most likely to benefit from Brazil's strong financial position: CPFL Energia S.A. (NYSE:CPL), a utility company engaged in the distribution, generation and commercialization of electric power in Brazil.
Electric utilities have stable margins, since they lock in both costs and rates they charge their customers ahead of time. (So they know how much they will likely make ahead of time.)
They also stand to benefit from a growing economy. In Brazil - especially in 2009 - that was a huge bonus. It was one of the few countries that were still growing despite the financial crisis that had struck a year earlier.
And because of its industry and country's stability and growth, CPFL's dividend yield was sitting at 7.8%. That's a huge yield compared to similar companies in the U.S., most of which were cutting their payments.
But since Brazil's banking and fiscal situation was more stable at the time than most places... and because it still had relatively high interest rates... the exchange value of the real was rising against the U.S. dollar.
Source: Yahoo! Finance
View Larger Chart
Since my readers were invested in a company that earned its cash in the Brazilian currency and paid shareholders in the Brazilian currency (which were only converted at the time of payment to dollars for my readers), their dividends also benefited from this increase in buying power.
In January 2009, the expected annual dividend for CPFL was $3.17. But because of the increase in the buying power of the real against the dollar, readers who bought shares actually received $3.73 per share. So our 7.8% dividend yield turned into 9.2%.
Now, I'm not saying it's easy to predict which currencies will gain against the dollar. But sometimes a clear opportunity arises to take advantage of a currency move like I did in 2009.
Besides, if you have all your eggs in one basket - by, say, investing all of your money in U.S. stocks - you open yourself up to a potentially ruinous loss should the dollar suddenly plunge in value.
And even if there is no big plunge, the steady drip, drip of dollar inflation will still take its toll.
My advice is to aim for having at least 40% of your portfolio invested overseas. Look for countries with low debt-to-GDP ratios, plenty of natural resources, relative high interest rates, fast-growing economies and strict banking regulations.
Currencies in these countries are likely to do well as the Fed continues to try to pulverize the buying power of the buck.
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