The Bright Side of the Declining Dollar
By Jeremy Vohwinkle with 13 Comments
If you have paid any attention to the economy or financial markets over the past year, you’re probably aware of the fact that the U.S. dollar has been sinking relative to most foreign currencies. While the effects of the declining dollar can be felt here at home, it has a greater impact in the global markets. Shown below is an image from Morningstar that shows the effect that exchange rates have on foreign investments in Japan, Canada, Europe, and the UK. Clicking on the image will allow you to download the full PDF.
Generally Better Returns
With the exception of Japan, in most cases your actual returns would be higher in terms of US dollars thanks to the declining value. The reason for this is because when you own a foreign investment, you’re actually holding the stock in the foreign currency that was purchased with U.S. dollars. While the dollar drops in value relative to that currency, when you sell your investment it converts back to more U.S. dollars.
For example, when the U.S. dollar dropped in value by 7.9% against the British pound, U.S.-held British investments increased by 10.1%.
A Case for Diversification
We always hear people talking about diversification, but the discussion typically just states that you should have a mixture of different types of stocks and bonds. While most experts suggest some international holdings, little attention is given to why you should invest internationally. There is more to consider than just buying a foreign company since the actual value of the U.S. dollar in the global market can have a significant impact that amplifies the actual gains or losses.
While this doesn’t mean you should go hog-wild and add a bunch of international investments to your portfolio, this is a good time to examine your foreign exposure and see if you need to change your holdings. If you think the U.S. dollar will continue to remain weak relative to other foreign currencies, you can help your portfolio out by using this weakness to your advantage.
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Some of those other markets can be pretty volatile, too. The Chinese markets in particular have been bouncing around like a yo yo.
While I think the dollar will eventually rebound, it won't happen overnight. Even if it does start to come back, it has a long way to go before it would put us in a reverse position where it would actually diminish foreign returns.
And as was already mentioned above, even if the dollar does begin to recover a bit, the low correlation with the domestic markets can still far outweigh the differences in exchange rate. The current value of the dollar just happens to amplify those returns.
The weak dollar has been great for investing in foreign stocks, but it seems like it's about time to start bringing money back to the US. The dollar will probably continue to slide some but it's better to anticipate the coming bottom and start moving out of foreign investments.
This is a good lesson for the future. However, investing in foreign stocks / funds now would be extremely risky. If / when the dollar reverses it's slide, that means your foreign investments will be worth less in dollars.
In other words, it's great to invest in foreign areas when the dollar is strong. Not so much when it's weak.
I've had foreign stocks, both in mutual funds and in individual stock picks, for 11 years already. Considering that half of the global market cap falls outside of the US, it'd be silly to restrict your investment choices to just this country. However, if you think the US$ is going to go down even more, a better choice would be precious metals and precious metals mining stocks. Why? Because foreign countries don't like to see their export industries suffering from their strong currencies either and their governments will intervene at some point. For example, I think the EU will intervene when the euro is at $1.50. So foreign currencies alone won't protect you from dollar devaluation.
The converse is also true, foreign investors get less return on US investments.
Sara, that must be tough in your situation. Your husband's income is all paid in US dollars, correct? That puts you in a difficult situation where most of your income is in US dollars, while you're required to live overseas.
If only I invested in foreign stocks /sigh
Diversification is always good, though my husband might not agree right now. I have my retirement savings in Canadian equity, global equity and Canadian income funds. When my husband started his, he put his money into US equity since it was the one area my portfolio hadn't touched. With the fall of the US dollar relative the the Canadian (and most other currencies), my portfolio looks brilliant, and my husband's makes him want to cry. I try to console him with the fact that we're well diversified as a couple and that my gains make up for his losses, and that the US market will pick up eventually, but it's still depressing for his first real go at the mutual fund market.
Currently I think Singapore Dollar and also Australian Dollar are a good choice for currency diversification.
That's right Shadox, the primary reason to hold some international stock is because of the weak correlation. The declining dollar just sweetens the deal even more for some regions.
Currency risk diversification is only one reason to go global. The real big pay off is the fact that international stock markets are not 100% correlated with the U.S. market, which leads to a less volatile portfolio.
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You are right mr. Harrison Singapore Dollar and also Australian Dollar are a good choice for currency diversification.
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