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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.

The modern investor has a wealth of new tools to achieve real diversification. Small investors are encouraged to spread their portfolios across a range of stocks and bonds. Small caps, mid caps, large caps, value, growth, short and long-term Treasuries, and municipal bonds have been the staple of a diversified portfolio. Well, times have changed and so too should your notions of eggs and baskets.

Exchange-traded funds (ETF’s) change the old notions of portfolio management. Individual investors can now add commodities (precious metals, corn, wheat, soy, cattle, oil, natural gas, etc.), currencies, and specific sectors of the economy just as easily as they can add stocks.

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.

Negatively correlated assets held in the same portfolio reduce overall risk. Risk, as measured by variance of returns, can actually be lowered simply by holding assets that do not move in the same direction. For instance, if stock A decreases 70% of the time stock B increases, and vice versus, then you could construct a portfolio that has less total risk than either A or B by including both.

Analyzing stock indexes in relation to major world currencies shows that Swiss Franc, Japanese Yen, and Swedish Krona have negative correlations to US stocks, while Mexican Peso, Australian Dollar, and Canadian Dollar are positively correlated. To get the most out of diversifying a US stock portfolio, it would be advantageous to include the former and exclude the latter. However, there are other reasons to invest in currencies, such as hedging declines in the US dollar.

Not only do currencies gain value relative to each other, but they also offer investors income through interest payments. So investors holding Swiss Franc, Euro, Krona, and Yen would have seen double digit gains from appreciation, along with dividends from holding the ETF’s.

For investors concerned with income, they should consider holding the highest yielding ETF’s: Australian dollar, Mexican peso, and British pound.

Currency ETF’s offer a great alternative to traditional methods of diversification and are great to offset further declines in our own currency. Consider that commodities price growth is largely attributable to US dollar depreciation and you can see how foreign currencies can insulate individuals from energy, food, and other commodity-driven inflation.