Conventional wisdom in creating a healthy, diversified portfolio needs to be updated to reflect new market opportunities. Small investors now, more than ever, have the opportunity to include what are historically institutional-only assets in their personal holdings.

An industry has been built around smooth talking salesmen advising people to diversify their portfolios into a variety of stock and bond products. These well-dressed businessmen extol the benefits of such and such value or growth stock fund. They sound sophisticated when they tell you that small caps are countercyclical to large caps, and so forth. The reality is that stocks are stocks and regardless of how you splice up and segment them into categories, they hold inherently similar correlations.

With the emergence of exchange-traded funds (ETF’s) there has sprung forth tremendous new tools for diversifying individual portfolios. Stocks and bonds can now be supplemented by precious metals, natural gas, oil, agricultural commodities, real estate, sub sectors of the economy (retail, financials, energy, etc.), targeted global markets, and currencies.

Americans should fear inflation and the long term decline of the US dollar. A great way to guard against these risks are to purchase foreign currency ETF’s. These are usually not correlated to bonds or US stocks, so offer a greater degree of overall diversificatoin to traditional portfolios.

Overall portfolio risk can be measured in the variance of returns, which is a function of the individual assets held. To decrease total system variance it is best to include assets that are negatively correlated to each other.

For currencies, it is necessary to analyze how they move in relation to US stocks, bonds, and other assets that are held in traditional portfolios. Doing so indicates that Japanese Yen, Swedish Krona, and Swiss Franc move opposite to US stocks, while Canadian dollar, Australian dollar, and Mexican peso move with stocks. So if your portfolio holds US stocks you should consider the former currencies and exclude the latter.

Including the negatively correlated currencies over the last year would have seen between 12% and 17% capital gains. This is due merely to appreciation relative to the US dollar. In addition to relative currency gains, each ETF offers dividends representative of each countries interest rates.

There are multiple consderations in portfolio theory, but applying the basics can have far reaching benefits. Those concerned with dividends should hold the highest yielding ETF’s, which include British pound, Australian dollar, and Mexican peso. On the flip side, income investors should avoid Swiss Franc and Japanese Yen.

Currencies offer another way for investors to lower their overall portfolio risks. By choosing negatively correlated currencies traditional portflolios comprised of stocks and bonds can achieve lower overall risks. Additionally, investors can protect against depreciation of their own currencies and gain exposure to higher interest rates offered on cash overseas.