Buying a currency fund protects you against a falling dollar. By Thomas M. Anderson, Contributing Editor February 28, 2007 Long synonymous with American might, the dollar today looks about as sturdy as a toothpick. It fell 4% last year against a basket of foreign currencies and a whopping 11% versus the euro. Thanks to big budget and trade deficits, a slowing economy and the possibility that the Federal Reserve will cut interest rates in 2007, the buck should weaken further. That may crimp your vacation plans by raising the cost of overseas travel, but it bodes well for a portfolio with a healthy dose of foreign currencies.When the greenback depreciates, investments in euros, pounds, yen and other currencies translate into more dollars. If you own an overseas stock or bond fund, you already have foreign-currency exposure (unless the fund hedges its currency positions). But the fund industry, ever alert for marketing opportunities, has begun to churn out currency funds. Rydex, for instance, has issued seven exchange-traded funds that are tied to the values of different currencies. Owning a currency fund allows you to bet against the dollar without taking on the risks of owning foreign stocks or bonds. In fact, the only currency fund with a long-term record, Franklin Templeton Hard Currency, has been about half as volatile as the typical diversified foreign stock fund. The Franklin fund, launched in 1989, invests in a diversified package of currencies. Michael Hasenstab, manager since 2001, invests in short-term debt of countries that historically have experienced low inflation rates. At last report, some of his biggest positions were in the Canadian and Singaporean dollars, and the Swedish krona. From its inception to January 16, the fund's Class A shares (symbol ICPHX; 800-632-2301) returned an annualized 5%. But since February 2002, when the dollar began sliding in earnest, the fund gained an annualized 10%. The Class A shares come with a 2.25% sales charge and sport an annual expense ratio of 1.19%. Advertisement A no-load alternative is Merk Hard Currency. Axel Merk, who started the fund in May 2005, invests in the currencies of several countries whose central banks aim to keep inflation in check. The fund (MERKX; 866-637-5386), which charges 1.30% for expenses, gained 12% in 2006. "We are targeting investors who don't consider the dollar the safe investment it used to be," says Merk, who has invested in currencies for private accounts since 1994. We don't recommend speculating in currencies. But given the likelihood that the dollar will continue to fall, keeping some money in foreign currencies makes sense. If you don't own an international stock fund and don't want to assume the risks of stocks, the Merk fund is an economical choice.