ETF Update: Currency Investing Made Easy, Muni Bond ETFs Looking Good, Double Trouble

Includes: ITM, MUB, TFI, UUP, VTI
by: Tom Lydon

Currency Investing Made Easy

Currencies once were the domain of the big-time investors, or were considered "too risky," but ETFs have made it easy for regular investors to get in on them, too.

These are interesting times for currency ETFs, says David Bogoslaw for BusinessWeek. The dollar was on a downtrend until recently, when it began showing some strength against the euro and other currencies.

The Federal Reserve's rate cuts and speculation that economic recovery in the United States might be speedy have had a hand in the recent performance. However, investors will still be concerned with reducing their exposure to U.S. equities and Treasury bonds and currency ETFs will attract interest.

Rydex Investments offers eight currency-focused ETFs, called CurrencyShares. They're structured as grantor trusts that hold the underlying currency and gain or lose value based on exchange rates and any overnight interest accrued.

Some believe that the euro has reached its limit, especially since European central banks are considering their own rate cuts. So, investors who want to take advantage of any potential rise in the dollar can do that, too: through either the Rydex Strenthening Dollar 2x Strategy H [RYSBX] or the PowerShares DB US Dollar Index Bullish (UUP) or by shorting the CurrencyShares.

The world's economies really seem to be at a crossroads and it's anyone's guess which way various currencies will swing. If trying to predict any one of those movements is too daunting, a diversified currency ETF, such as the PowerShares DB G10 Currency Harvest (NYSEARCA:DBV). The fund goes long on futures of three currencies with the highest interest rates and short on those with the lowest.

Whatever route you take, currencies work best in a well-diversified portfolio. Don't put all your currency in one basket.

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.

Muni Bond ETFs Looking Good

Competitive yields are suddenly giving municipal bond ETFs a new level of attractiveness to investors.

Muni bond ETFs are the new kids on the block; the first ones didn't appear until last September.

On Feb. 1, the Market Vectors Lehman Brothers AMT-Free Intermediate Municipal Index (NYSEARCA:ITM) was yielding 3.49%. It targets the 6- to 16-year part of the yield curve, reports David Hoffman for Investment News. Another bonus: the yield paid out by munis is free from federal taxation, making their effective income greater than the taxable yield offered right now by Treasury bonds.

Other comparable muni ETFs tell a similar story: the iShares S&P National Municipal Bond Fund (NYSEARCA:MUB) had a yield of 3.44%, but the tax equivalent yield was 5.07%. The SPDR Lehman Municipal Bond ETF (NYSEARCA:TFI) yielded 3.34%, with a tax equivalent of 5.14%.

James Colby, Van Eck's senior municipal strategist, says muni bond ETFs are a good option for those investors uncertain about what's going to happen in the Treasury markets. I don't see anything wrong with this strategy, and the municipal bond ETF environment appears relatively safe.

There's always risk, though, including with these types of bonds. That's because the governments behind them pay companies to insure them so that ratings agencies will give them a better rating. However, these companies are at risk of defaulting because they also insured subprime mortgage-backed securities and they're not as in sound financial shape as investors previously believed.

As a result, ratings agencies have started to downgrade bond insurers. At least one agency lost its AAA rating, reports Martin Z. Braun for Bloomberg. The default rate on municipal bonds in 0.1%, but Moody's Investors Service says state and local government debt is still tainted. The threat of more downgrades is something to watch out for.

Double Trouble

When you look at your ETF portfolio, and consider all of the single stocks that you own, are you ever doubling up?

Investing in individual large-caps is great, however, if you also own any part of the S&P 500 through an ETF or mutual fund, you may be too heavily weighted in U.S. large caps. Tim Hanson and Brian Richards for The Motley Fool want to know if that's the kind of asset allocation you intended. Probably not. You could do worse than the S&P 500, of course: it has a roughly 10% historical annual return.

Even within the most conservative game plan, though, there should always be room for small-caps. After all, they're the best-performing stocks on the market. Whether it's 10% or 30%, depending on your risk tolerance, the returns will help you beat the market over the long-term and maximize your savings, especially if you manage to pick the right small-caps.

If you own a broad-based ETF such as the Vanguard Total Stock Market (NYSEARCA:VTI) and also own stock for, say, Exxon Mobile (XOM), General Electric (GE) or Citigroup (C),you may have unknowingly doubled up on these market mammoths. Make sure to review your portfolio and know what you're holding so that get exposure to different asset classes.