To begin with, it’s important to understand just what is meant by a “strong” dollar. The U.S. dollar does not exist in a vacuum — its value, from a global perspective, is determined by its changing strength relative to that of other currencies. Let’s look at an example: Suppose that, in 2011, you traveled to Europe and wanted to trade in one dollar for its equivalent value in euros. At that time, your dollar would have converted to about .75 of a euro. Fast forward to early 2015; if you returned to Europe now, your dollar would fetch you almost one full euro. In other words, you can buy more euros because the dollar is “stronger.”
In fact, earlier this year, the euro hit a 12-year low versus the dollar. And it isn’t just the euro; the dollar is strong against almost every other major currency in the world. What has led to this strength? It’s not always easy to determine what’s behind foreign exchange rates — which can fluctuate even more than the stock market — but the recent surge in the dollar seems to be due, at least in part, to its obvious connection to the American economy, which has been growing faster than many other economies around the world. The stronger dollar is also due to expectations that interest rates will remain higher in the U.S. than in many other countries.
But whatever the reasons for it, the dollar’s strength may be having an impact on your investments. A strengthening dollar typically lowers returns from international investments because you get fewer dollars in exchange for the value in euros or other foreign currencies. And some U.S. companies with a global presence may face challenges due to lower earnings from their international operations.
These results might lead you to think that a strong dollar would be bad news for the stock market, but that hasn’t been the case in the past. At different times, the markets have performed well with both a strong and a weak dollar.
In contrast to its impact on U.S. companies, a strong dollar can help foreign companies compete and may give them an earnings boost from their U.S. sales. Also, the stronger dollar can help make foreign investments “cheaper.” Even more importantly, by taking advantage of the stronger dollar and investing an appropriate amount internationally, gaining exposure to different economies and markets, you can help diversify your holdings, which is important. Although diversification can’t guarantee a profit or always protect against loss, it can help reduce the impact of volatility on your portfolio. Be aware, though, that international investing carries special risks beyond currency fluctuations, including political and economic instability.
The strong dollar may have attracted your attention, but don’t be distracted by it — and don’t overreact. Currency exchange rates can fluctuate rapidly, and no one can predict how long a strong dollar environment will last. By sticking with a solid, long-term investment strategy, you can help keep up the “strength” of your own dollars.