The value of an investment is impacted not just by returns in its local market, but also by the value of the currency in which it's denominated. How might dollar fluctuation impact your portfolio and what can you do about it?
The dollar, the euro, and other global currencies affect businesses and investors in one way or another, even if few of us are doing much world traveling these days. More than $5 trillion in currency changes hands every day, so it’s a good idea for investors to keep an eye on foreign exchange (FX) markets and understand the implications of a strong dollar versus a weak dollar and other currency matters.
“All investments are denominated in a currency, and the value of an investment is impacted not just by returns in its local market, but also by the value of the currency in which it is invested,” said Keith Denerstein, director, guidance, at TD Ameritrade. “That means the value of a dollar-based investment can increase or decrease relative to other currencies. You want to make sure your investment decisions account for fluctuations in the dollar and consider ways you can protect your portfolio from them.”
Where does foreign exchange fit into your portfolio analysis? Here are four things to consider.
Many of the companies in U.S. benchmarks like the Dow, S&P 500, and Nasdaq have operations outside the United States. If a company is doing business in, say, France, it’s initially paid for its products or services in euros. When the company reports financial results, those euros are then converted to dollars.
“If you’re investing in a company that does business across borders, then that company will receive revenue and incur expenses in the local currency,” Denerstein explained. “And, as those currencies change, the company’s bottom line is impacted. Most large companies are going to be impacted by international currency fluctuations in some way, and even some small companies sell products or source some inputs from overseas.”
In foreign exchange, one currency is traded against another as a “pair,” meaning you’re effectively buying one currency and selling another at the same time. The most actively traded and widely followed pairs include the dollar versus the euro (EUR/USD), the British pound (GBP/USD), the Canadian dollar (USD/CAD), and the Japanese yen (USD/JPY).
A forex currency pair quote tells you the cost to convert one currency into the other. For example, at the beginning of February, it took about $1.21 to buy one euro. USD/CAD was trading at roughly $1.28, meaning one U.S. dollar was equal to $1.28 Canadian. (Learn more about the forex market.)
Want a single snapshot of the dollar versus the currencies of several of the United States’ largest trading partners? The U.S. Dollar Index ($DXY) is a basket consisting of the four above, plus the Swedish krona and the Swiss franc.
For U.S. investors, it’s worth keeping an eye not only on the dollar, but the currencies for the countries with which your companies engage in the most business, Denerstein noted.
With currency markets, investors “should focus on large economies and large trading partners,” he said. “As you zoom into a particular company, you want to know in what countries it has significant parts of its operations and follow that currency pair as well.”
Is dollar strength good or bad? It depends.
The dollar is considered a “reserve” currency, meaning many assets, including commodities like gold and crude oil, are denominated in dollars on the world market. For consumers, the primary benefit of a strong currency is purchasing power. A “strong” dollar has long been seen as a point of pride or source of power—when there’s trouble somewhere in the world, you can always count on the dollar to be worth something.
By contrast, a weaker dollar makes it cheaper for foreigners to buy U.S. goods, because they can purchase more of our goods and services because each unit of their currency converts into more dollars.
Over the past year, the dollar weakened against some major counterparts (in early February, the dollar was about 7% weaker against the euro, compared to the end of 2019). The weakness reflected near-zero interest rates and accommodative monetary policy in the United States as central bank leaders sought to stimulate the economy during the pandemic.
Currency traders often closely follow top U.S. officials like the Treasury Secretary for indications on any inclinations on dollar strength or weakness. Traditionally, U.S. government officials tended to say—publicly, at least—that they favored a strong dollar, as an expression of confidence in our economy.
According to Janet Yellen, recently confirmed as Treasury Secretary, the Biden administration won’t seek a weaker currency in a bid to gain an advantage on U.S. competitors. The United States “does not seek a weaker currency to gain competitive advantage,” Yellen said. She believes “in market-determined exchange rates” and opposed any efforts to artificially manipulate currency values.
Still, there’s what the Treasury secretary says and what the dollar actually does. That’s one reason to watch for potential shifts or inflection points in the strong-dollar versus weak-dollar dynamics.
The foreign exchange market itself can be unpredictable and volatile, and it’s full of savvy professional traders, so trading currencies is not for everyone. Still, there are a few ways investors can consider currency-related positions that may provide some protection from swings in the dollar.
For example, there are a number of hedged exchange-traded funds (ETFs) that could be used to express views on a currency or hedge exposure to a certain country or market, such as a hedged version of an ETF to provide pure exposure to a currency like the pound or yen, Denerstein mentioned.
Additionally, ETFs linked to commodities such as gold or grain might be worth a look. Because many commodities are priced in U.S. dollars, when the dollar weakens, the price of a commodity rises, as it takes more of those dollars to buy a bushel of wheat or a pound of copper.
Many currencies are priced based on U.S. dollars, and many major global commodities, such as oil and grain, are priced in dollars. That means a stronger dollar may be bearish for commodities.
Gold is different. It’s considered a store of value. If the dollar were to weaken significantly, many investors may turn to gold, based on the belief they’re holding an asset that’s a store value. Gold prices can be viewed as an indicator of investor sentiment on the direction of the dollar. If markets expect higher inflation and/or dollar weakness or devaluation, gold prices may rise.
Portfolios with holdings with exposure to a variety of countries may more easily recover from volatility caused by geopolitical events. Although geopolitical news often affects some sectors negatively, it can also affect other sectors positively.
For investment guidance for your unique goals, get our custom support and recommendations from TD Ameritrade Investment Management, LLC.*
After all, your best strategy should start with you.
Bruce Blythe is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Carefully consider the investment objectives, risks, charges and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.
ETFs can entail risks similar to direct stock ownership, including market, sector, or industry risks. Some ETFs may involve international risk, currency risk, commodity risk, leverage risk, credit risk, and interest rate risk. Trading prices may not reflect the net asset value of the underlying securities. Commission fees typically apply.
All investments involve risk, including loss of principal. Past performance does not guarantee future results. There is no assurance that the investment process will consistently lead to successful investing.
Asset allocation and diversification do not eliminate the risk of experiencing investment losses.
Investments in commodities are not suitable for all investors as they can be extremely volatile and can be significantly affected by world events, import controls, worldwide competition, government regulations, and economic conditions.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2021 Charles Schwab & Co. Inc. All rights reserved.