What will happen to my U.S.-based stock portfolio if the U.S. dollar substantially decreases in value?

By Rob Renaud AAA
A:

The effect of a significant depreciation in the value of the U.S. dollar on the value of an investor's U.S-based portfolio is very much a function of the portfolio's contents. In other words, if the dollar declines substantially in value against a number of other currencies, your portfolio might be worth less than before, more than before, or about the same as before - it depends on what kinds of stocks are in your portfolio.

The following three examples illustrate the different potential effects of a declining greenback on an investor's portfolio:

1. Worst-Case Scenario: Your portfolio is made up of shares of businesses that rely heavily on imported raw materials, energy or commodities to make money. A substantial portion of the manufacturing sector of the U.S. economy depends on imported raw materials to create finished goods. If the purchasing power of the U.S. dollar declines, it will cost manufacturers more than it did before to buy the goods, which puts pressure on their profit margins and, ultimately, their bottom lines.

Companies in your portfolio that don't properly hedge against their reliance on the price of imported goods or the effects of a low greenback can expose you to a lot of foreign exchange risk. For example, a company that makes baseball bats with imported wood will need to pay more for the wood if the U.S. dollar declines. In this case, a lower U.S. dollar will present a problem to the company because it will have to decide whether it will make less money per unit sold or raise prices (and risk losing customers) to compensate for the higher cost of wood.

2. Likely Scenario: Your portfolio is made up of a diverse collection of companies and is not overweight in any one economic sector. You have also diversified internationally and hold stock in companies that operate around the world, selling to many different markets. In this situation, a declining dollar will have both positive and negative effects on your portfolio. The extent to which the companies you own depend on a high or low U.S. dollar to make money will be a factor, but you'll probably be fine. Many of the companies in a typical portfolio hedge the risk of a U.S. dollar depreciation on their business, which should balance out the positive and negative effects of the change in the greenback. (To learn more, see Going International and Investing Beyond Your Borders.)

3. Best-Case Scenario: Your portfolio is made up of companies that export U.S.-manufactured goods around the world. Companies that rely substantially on foreign revenue and international exports stand to do very well if the U.S. dollar depreciates in value because they get a larger number of U.S. dollars when they convert from other world currencies. These companies sell products around the globe, and a low dollar just makes high-quality American goods more price competitive in international markets.

For a more in-depth look at foreign exchange hedging and other corporate hedges, see Corporate Use Of Derivatives For Hedging.

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