The Impact of The Strong Dollar And Your Wallet
Before we can see the impact the strong US Dollar has on your investments, we first have to understand how it impacts your wallet. Basically, a strong dollar means two things to consumers:
- The cost of buying American goods here in the US is more expensive
- The cost of buying foreign imports here in the US is less expensive
This is both good and bad news as some things will be cheaper to buy, like gasoline, while other things, like orange juice, will be a little more expensive to buy. At the end of the day though, a stronger US Dollar is seen as a good thing for consumers, especially if you travel abroad.
This is because a stronger US Dollar will allow you to buy more overseas with your dollar than you could otherwise. While the difference won’t be drastic, it is still a benefit to travelers in the end. In fact, some experts are saying that it is 15% cheaper to travel to Europe now than compared to this time last year.
How A Strong Dollar Impacts Your Investments
While getting a bargain on international travel is great, how exactly now does a strong US Dollar impact your investments? There are a few areas to look at. First, in terms of the market as a whole, a strong US Dollar is a good thing. Foreign investors will be putting money into the US stock market to take advantage of the growing US economy. The economy has been strengthening since the Great Recession and as the economy strengthens, so does the dollar.
Foreign investors see the US economy growing faster than other economies and want to take part in the faster growth and potential higher returns that the US stock market offers compared to their own economy.
From a business standpoint though, a stronger dollar complicates things. You have to look at two sides of the coin – the businesses that are multinational in nature, and those that are not. We will look at the multinational businesses first.
The multinational businesses tend to be large cap stocks that do a fair amount of business overseas. This can be a problem when the US Dollar rises because when selling in a foreign country, they are paid in that local currency. The business then has to exchange the local currency for US currency. Since the US Dollar is strong, they will end up earning less than they thought.
For example, let’s say $1 USD is equal to €1.06 Euros. If a business earns €10,000 Euros they made $10,587 USD. With an exchange rate this low, US business will have a smaller profit and, as a result, could see pressure on its stock price. Using the example of travel costing around 15% less, you can wager that many businesses are seeing a drop of close to this same amount simply due to the exchange rate.
In addition to this, with a stronger US Dollar, these US companies will have to sell their goods at a higher price compared to what local competitors are selling goods for. This can also hurt the bottom line in terms of lower sales volume.
Since larger companies do a fair amount of business overseas and these businesses make up the S&P 500 Index, the index could face headwinds as the dollar continues to strengthen.
On the other hand, you have small businesses, which tend to not do very much business overseas. As a result, they are not impacted as much by a strong US Dollar in terms of a weak exchange rate. They are however impacted as the price of goods here in the US rises. They can either see an increase in sales, based off of the increase of prices or a decrease in sales as consumers buy cheaper foreign goods instead.
As the US Dollar has been strengthening, small cap stocks have been performing well through this year.
There is yet a third side to the coin as well in terms of international businesses. Even though their economies are growing more slowly compared to the US, with higher prices of US goods on their shelves, local businesses in foreign countries can see an uptick in sales and thus start to strengthen their economy more quickly.
The same idea applies for large international businesses that sell here in the US too. Their products will be cheaper compared to their US competition and, as a result, could see an increase in sales.
How To Invest Based On This Information
So how should you invest based on this information? A quick read might make you think to avoid large cap stocks and only invest in small cap stocks. But, this could be a recipe for disaster.
As we all know, no one, not even professional money managers can beat the market on a consistent basis over the long term. So the odds of an individual investor doing so are slim to none. Your best option is the same as it has always been which is to invest in a well-diversified portfolio that is made up not only of large and small US stocks, but also of international stocks as well. Investing in this manner ensures that you earn a decent return on your money and at the same time reduce your risk.
It also ensures that you pick the winners too. In this case the winners could be small cap stocks, or it could be large cap stocks. No one really knows. So instead of flipping a coin to decide where to invest, you are better off allocating your money into various indexes and reaping the rewards, regardless of what happens. This is how successful investors make money over the long-term, by reducing risk and investing in a broad based portfolio.
Knowing exactly how the strong US Dollar affects your wallet is a lot more complicated than it seems to be. Even the experts are at odds for what to do. Some want to start raising interest rates because they feel as though the US economy is strong enough to handle it. Others feel that since a strong dollar helps to keep inflation low, a hike in interest rates is not needed, since the overall goal is to keep inflation at bay.
The only sure things are that a well-diversified portfolio is the way to go in terms of investing and that you can save money if you travel overseas when the US Dollar is strong. Everything else is just theory.
Author Bio: Jon blogs at Money Smart Guides, a personal finance blog that helps readers pay off their debt and start investing for their future.
(Photo courtesy of c_ambler)