Here’s why investors shouldn’t be happy about that.
The U.S. Dollar Index, which measures the strength of the dollar against a basket of foreign currencies, is up 18% over the past year.
A strong dollar is great news for tourists. It means that your money goes further when you travel.
But investors should not be happy about a stronger dollar.
“When the dollar gets stronger, that means that money from other countries will be worth less dollars. Sam Stovall, chief investment strategist at CFRA Research, says that these earnings will be lower. He also says that if the dollar goes up, any overseas investments you have will hurt you.
Here’s why experts say a strong dollar could be bad for your portfolio and what you might be able to do about it.
Why a strong dollar is bad for your investments
When the dollar is strong, money brought in from other countries in weaker currencies can only be changed into fewer dollars. This makes it harder for companies to make money.
Your international exposure will have a direct effect on your portfolio, which could be bigger than you think. Analysts at the investment firm Evercore say that about 30% of the S&P 500’s revenue comes from outside the United States. The S&P 500 is a measure of the whole U.S. stock market.
Even more so if you have a collection of international stocks, which is often suggested as a way to diversify your portfolio.
“The strong dollar hurts U.S. investors who own international stocks because they don’t get the benefits of a local market,” says Todd Rosenbluth, head of research at the investment analytics firm VettaFi. “This year, the dollar has made it much harder for international strategies to work.”
As an example, the MSCI EAFE Index, which is a standard for stocks from developed countries outside of the United States, has lost more than 20% so far in 2022. When currency changes are taken out of the equation, the index has lost about 7.5%.
How to change your investments to account for a strong dollar
As with any short-term market change, experts say you shouldn’t make big changes to your portfolio or change your long-term investing plans. But experts say that you can take action against the effects of the stronger dollar by making a few changes to your portfolio.
By putting more of your U.S. stock money into small or medium-sized companies, you can lower your exposure to the multinational companies that are hurt the most by the dollar.
Rosenbluth says you might also want to think about putting more money into parts of the economy that are less likely to make money from overseas. “Sectors like utilities and real estate get most, if not all, of their income from the U.S., while staples and health-care companies tend to be more international.”
You can buy funds that track “currency-hedged” versions of international stock indices for your foreign holdings. The managers of these funds buy and sell derivatives to take out the effects of currency changes on the returns of the stocks that the funds invest in.
Rosenbluth says that it lets you focus only on how the individual companies in the fund are doing.
When the dollar is strong, these funds tend to do better than their unhedged counterparts and do worse when the dollar is weak. However, over long periods of time, the return you get from a hedged product and an unhedged product tends to be pretty similar, according to a 2020 study from Morningstar.
There are a few other differences between hedged and unhedged funds, and Rosenbluth says that the choice of which to hold comes down to personal taste.
But don’t try to time currency fluctuations to make short-term profits by buying one or the other. “You’re just as unqualified as I am to predict whether the dollar will continue to strengthen over the next 12 months,” he says.
