By Allen Ostrofe MBA, CFP®
Mary and Ryan called recently from Kamas, Utah. They are both in their early sixties, have a modest portfolio, are closing in on retirement, and have successfully split their long-term investment savings between securities and real estate. They have been feeling confident about how their outlook for our economy is tied to their investment growth goals. During a recent review of assets in their securities portfolio, they became concerned due to recent news articles about the fluctuation of the Dollar, Yuan, Yen, Euro, etc., and wondered how this might impact their nest-egg. Do they need to take action now to protect the value of their investments?
Simplistically, it can be cheaper for Mary and Ryan to travel overseas, when the Dollar goes up. However, it could be a bad thing for U.S. manufacturers when the Dollar goes up. It makes their goods and services more expensive overseas and gives a potential competitive advantage to foreign corporations. The value of Mary and Ryan’s investments could also be significantly impacted by changes in global exchange rates. All investors should appreciate the influence that the foreign exchange market has on their securities portfolios, and their level of currency exposure, even if investments appear to be in U.S. companies. For example, XYZ, Inc. sells products and services in the United States for U.S. Dollars, in France for Euros, in India for Rupees, in Japan for Yen, and in China for Yuan. After receiving these foreign currencies, XYZ, Inc. converts the currencies back to U.S. Dollars. Changing exchange rates influence the earnings XYZ, Inc. receives. In turn, Mary and Ryan’s investments are impacted by this activity. This currency exposure presents them with both a currency risk and a transaction risk.
In recent years, the Dollar had become increasingly stronger, while the Chinese have allowed their Yuan to become weaker. For foreigners, this makes buying Chinese goods more attractive, and makes buying U.S. goods more expensive. This puts financial pressure on U.S. manufacturers, farmers, and service providers, and potentially decreases our exports and U.S. stock values. Some argue that now is the time to reduce the value of the U.S. Dollar to attract more foreign buyers of our goods. Mary and Ryan would be well advised to pay attention to prospective changes in currency valuations, as it could definitely impact their investment performance. Here are some actions they could take now, in regard to their specific situation:
1. 3 Correlations
There are three general correlations between stock price performance and exchange rate fluctuations: zero correlation, negative correlation, and positive correlation. Ask your Certified Financial Planner (CFP®) to identify which portions of your investments have a positive or negative correlation to the Dollar moving up or down.
2. International ETF
If you want exposure to overseas companies, but don’t want currency movements to impact your return, the cheapest and easiest way to eliminate currency risk may be to buy international exchange traded funds (ETF’s) that are hedged back to foreign currencies.
3. Leveraged Currency-Focused ETF
If you believe that the Dollar will weaken, and a foreign currency will strengthen (eg. Japanese Yen), you could buy a leveraged currency focused ETF that profits from a strengthening Japanese Yen.
4. Multinational Stocks
Empirical evidence supports the notion that U.S. shareholders’ multinational stocks win when the Dollar loses.
There is simply no doubting the benefits of owning foreign securities in your portfolio. After all, Modern Portfolio Theory has established that the world’s markets do not always move in lockstep, and that by mixing asset classes with low correlation to one another in a tactical allocation, risk can be reduced at the portfolio level.
Mary and Ryan now understand the risk associated with foreign currencies and have reallocated their international holdings with a plan. In the meantime, with a relative strong Dollar, they are off to vacation!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes.
Allen Ostrofe, MBA, CFP®, is President Emeritus of Ostrofe Financial Consultants, Inc., with clients in 32 states and is a registered Representative with, and Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Ostrofe Financial Consultants, Inc., a Registered Investment Advisor and separate entity from LPL Financial. For questions or suggestions, visit ostrofefinancial.com. Branch address: 420 Sierra College Drive, Suite 200, Grass Valley.