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.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.