Advanced Personal Finance

International investing is gaining in popularity, and with good reason. International index funds have outperformed most U.S. index funds for the past several years. And as that performance continues, more people are pouring money into overseas markets. The Wall Street Journal reports that, according to the U.S. Treasury, in March U.S. investors bought $40.3B more foreign stocks and bonds than they sold. Only December 2006 had a higher monthly outflow.

International investing is typically used to diversify a portfolio, but it also has a hidden benefit - currency risk. Currency risk is the risk that one currency’s value will fluctuate relative to another. The U.S. dollar has been falling recently and in my opinion will continue to do so. As the U.S. dollar depreciates, foreign stock and bond gains are magnified.

The effect of all this foreign investing further depresses the dollar. That leads to more attractive gains, which leads to additional investment. The cycle is self-reinforcing.

Euro versus Dollar

It is called currency risk for a reason, however. Should the dollar strengthen, any gains in foreign investments will be tamped down. If foreign investments turn negative (and they are historically more volatile than their U.S. counterparts), those losses will be magnified that much more.

I’m personally convinced of two things relevant to this discussion - the dollar will continue its 4-year slide and foreign stocks will continue to perform strongly. I’ve recently changed my 401(k) allocation to reflect that sentiment.

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