Weak-Dollar Woes

Bobby Arrington, a semi-retired software engineer in Plano, Texas, enjoyed his latest trip to Italy a little more than a year ago-what he didn’t enjoy was the hit to his wallet. “For my wife, Tita, and me to buy round-trip train tickets between Florence and Rome, the cost was around $110,” he says.

Now the Arringtons are planning a trip to the Philippines. “A few years ago, we could get 52 pesos to the dollar,” says Arrington, 59. “Now I’m expecting a dollar will bring as little as 38 pesos. Everything will be more expensive.”

Indeed, the declining value of the U.S. dollar has been in the news for several years. What does a crumbling currency mean for U.S. investors? Dan Lefkovitz, a senior mutual fund analyst at Morningstar, a Chicago-based research firm, provides this illustration: Think back to 2002, when the dollar began to drop. Assume you invested in a fund designed to track the MSCI EAFE Index, the most popular benchmark for foreign stocks. What’s more, suppose you invested in a hedged version of this fund, meaning that all currency fluctuations were stripped out. Over the next five years, to the end of 2007, you would have enjoyed a 10.4% annualized return. Not bad. But if you had invested in the same fund without the currency hedge, and thus enjoyed upward movements in pounds, euros, and Swiss francs, your annualized return would have been 16%.

To put that in perspective, a $10,000 investment grows to around $17,200 in five years, at a 10.4% rate. At a 16% rate, though, that same $10,000 grows to more than $22,700. The $5,500 difference would be attributable to currency fluctuations.

Focusing on funds
If you believe that the U.S. dollar will stay weak or may fall even further, one way to bet against the buck is to buy foreign funds without the currency hedge (most foreign funds fall into that category). In fact, that’s the strategy currently embraced by the Arringtons.

“My financial planner, Kevin Davis, suggested in 2006 that I invest in international funds,” says Arrington. “I did, and I’m very pleased with the results so far.” Davis, a certified financial planner with Dallas-based Consolidated Financial Services, says his research led him to conclude that a global portfolio could outperform one that was domestically oriented. “Growth outside the U.S. may exceed economic growth here,” he says. If America is a relative laggard, the U.S. dollar also could continue to decline. In such a scenario, foreign stocks and funds would post superior returns. “My clients tend to have 20% to 40% of their portfolio in foreign funds,” says Davis. “Bobby Arrington is at the upper end of that range. With his risk tolerance and his modest spending habits, he can be more aggressive.” Arrington’s portfolio now includes a diverse range of international offerings from American Funds: EuroPacific Growth (AEPGX), New World (NEWFX), Capital World Growth & Income (CWGIX), and Capital Income Builder (CAIBX).

“Today, having a domestic-only portfolio may be too risky,” says Leslie Williams, a financial adviser