The dollar has been on a roll over the last year, with the U.S. Dollar Index, which gauges the currency’s strength versus a basket of international currencies, up 18%.
A strong dollar is fantastic news for travelers. If you travel overseas, you can get more for your money. On the other hand, a stronger dollar is terrible news for investors.
As the dollar increases, international income will be translated into fewer dollars. Sam Stovall, the chief investment analyst at CFRA Research, says those earnings will be reduced, adding that any international investment you have “will damage you in a rising dollar scenario.”
Here’s why investment experts believe a strong dollar will harm your portfolio and what you can do about it.
What a strong dollar does to your portfolio
A strong dollar reduces overseas income earned by corporations because the money in the form of weaker foreign currencies is transformed into fewer dollars. The impact on your portfolio is proportional to your overseas exposure, which may be more than you realize. According to Evercore analysts, around 30% of sales in the S&P 500 — a gauge for the broad U.S. stock market — originate from overseas.
If you possess a variety of overseas companies and a popular strategy to diversify your portfolio, the impact on performance is much more pronounced.
The strong dollar punishes U.S. investors who buy overseas shares because they don’t enjoy the benefits of a local market, says Todd Rosenbluth, head of research at investment analytics firm VettaFi. This year, the dollar has considerably harmed the performance of an overseas strategy.
As an example: So far, in 2022, the MSCI EAFE Index, a gauge for stocks from developed international countries, has lost more than 20%. A version of the index that excludes currency swings has lost around 7.5%.
Getting Your Portfolio Ready for a Rising Dollar
As with any short-term market development, experts advise against making wholesale adjustments to your portfolio or deviating from your long-term investment goals. It may be necessary to adjust your portfolio to protect yourself from the consequences of the stronger dollar.
Shifting your allocation to small- or midsize-company stocks among your U.S. stock holdings might reduce your exposure to multinational firms, for which the dollar is the most drag.
Rosenbluth suggests increasing your interests in sectors of the economy that are less likely to generate gains from outside. In sectors like utilities and real estate, most revenue comes from the United States, while in staples and health-care corporations, most comes from abroad.
You can buy funds that track “currency-hedged” versions of international stock indices for your overseas assets. These funds’ managers use derivatives to offset the effects of currency volatility on the returns of the underlying equities. “It allows you to concentrate entirely on the performance of the fund’s firms,” Rosenbluth explains.
These funds tend to outperform their unhedged counterparts during periods of currency strength and lag in times of dollar weakness. Still, over extended periods, the return you obtain from a hedged versus an unhedged product is generally equal, according to 2020 Morningstar research.
According to Rosenbluth, there are a few more distinctions between hedged and unhedged funds, and the decision to hold either is ultimately a matter of preference.
“You’re just as unqualified as I am in estimating whether the dollar will continue to grow over the next 12 months,” he cautions.