A New Kind of Diversification

As I was reading the news about J.P. Morgan's buyout of Bear Stearns, I had a thought about how I could maneuver my own personal investments to weather the current financial storm.

A basic technique to mitigate risk in an investment portfolio is through diversification; that is, owning a number of assets of different enough types so that poor performance in one category of asset is balanced or outweighed by better performance in at least one or more other categories of assets that you own.

Good retirement portfolios follow this principle, and have a certain proportion of their value in asset classes like "large cap", "small cap", "international", etc.

The problem lately is that even if your portfolio does well it's still denominated in dollars (if you're an American). So if you manage to accumulate a few million by your retirement time, it's not worth much if a bag of potato chips costs $500.

So I had an idea: let's add another dimension of diversity to a well-balanced investment portfolio, and that's not by holding a new asset class (there's a diminishing return beyond a certain number of assets, 30 is that number I believe) but by diversifying the currency in which the assets themselves are denominated.

By holding a well-balanced portfolio, with each distinct asset class diversified in a basket of different counter-balancing currencies, you mitigate both industry risk and currency risk.

I'm not sure if it's possible yet, for an individual to hold foreign-denominated equity positions, but in theory it seems like a good idea. Especially if you don't like buying gold at $1,000/oz.