The U.S. dollar, like other currencies, is volatile. As with any economic factor that affects the markets, a declining dollar may impact your 401(k). Hedging is the practice of reducing risk by adding investments that offset negative effects. Although you may hedge against a falling dollar, basing 401(k) investment decisions on changing market conditions may not be the best strategy.
A 401(k) is a retirement plan named for the section of the tax code that governs it. The plans were created to supplement pensions, which employers funded and managed at great expense, but they have largely replaced them. Such plans are funded with defined contributions, which means the employee contributes a specified amount of pretax earnings from each paycheck. Many employers match some or all of employees' contributions. Employees have control over how their money is invested. Most plans make available a variety of stock, bond and cash investments.
Hedging Against a Falling Dollar
You may take steps to hedge against the effects of a falling U.S. dollar. Time Magazine notes that keeping 25 percent of your stock allocation in funds that invest in foreign companies serves as a hedge against a weak dollar and a slow economy. Funds that invest in foreign currencies and precious metals and other commodities may also protect your 401(k) against dollar devaluation. Investopedia suggests investing in funds with stocks from U.S. companies that do a lot of business outside the United States, particularly if those countries' currencies are tied to the dollar. he protective effects of these strategies result from the fact that these investments correlate inversely with the dollar -- that is, they tend to rise when the dollar falls and they tend to fall when the dollar appreciates. Note, however, that correlation doesn't necessary signify a cause-and-effect relationship, and correlations are not necessarily permanent.
Rolling Over Your 401(k)
Many 401(k) plans' investment choices are too limited to allow you to aggressively hedge against a falling dollar. However, you may roll your 401(k) into an IRA if you change employers. An IRA gives you many more investment choices, notes Mayflower Capital. To avoid penalties, you must roll the 401(k) funds directly into the IRA.
Should You Hedge?
CNN Money notes that chasing markets up or down doesn't work. The safest strategy is to pick an asset mix that over time can withstand fluctuations and changing conditions such as currency volatility. Experts recommend that you not touch your account except to rebalance it once or twice a year. They note that re-allocation is best reserved for changes in strategy due to such changing needs as a shift to more conservative investing as you near retirement.
Your account becomes unbalanced when gains or losses cause a higher or lower percentage of your account to be allocated to any particular category. For example, if your original allocation was 50 percent stocks and 50 percent bonds, and stocks have gained while bonds have lost, your current stock allocation might be 70 percent while your current bond allocation is 30 percent. You rebalance by selling some of your stock investments and/or by allocating more of your contributions to bonds until you bring the account back into balance. According to CNN Money, rebalancing keeps you buying low and selling high, which is a smart way to invest and the way 401(k)s are meant to work.
- Investopedia: Investopedia Explains "Hedge"
- Investopedia: Inverse Correlation
- InvestorPlace: How to Defend Yourself Against a Falling U.S. Dollar
- InvestorPlace: What Is a EFT Investment?
- SmartMoney: Playing the Falling Dollar
- The New York Times: 401(k)s: What You Need to Know
- Investor Place: Look to the Dollar for Market Direction
- Mayflower Capital: How to Protect Your 401K From Treasury Default
- Time Magazine: Why It's Time to Retire the 401(k)