Will a Falling Dollar Derail Your Plans for Retirement?

How much are you willing to pay for a tank of gas? We've all watched as gas prices hit record highs, but what would you do if you filled your tank and paid by credit card only to discover on your monthly statement that you paid $80 to fill an economy car. No, this is not some future doomsday projection of oil prices. This scenario recently happened to a colleague on business in Europe.

You're not planning a trip to Europe, so you ask, "Who cares?" Well, the consequences of a weakening dollar are not limited to overseas transactions. It's important for you to know exactly how the declining US currency affects Americans state-side.

What does this mean to you?

The US dollar is considered the world trading currency. This means that most goods and services are priced in US dollars. Any prolonged weakness will cause countries trading with the US to raise their prices in anticipation of further decline. Many commodities such as, oil, coffee, chromium, copper, and iron have already set record prices due to the decline in the dollar. As the prices for foreign imported goods increase, so do the prices for the raw materials and parts used by US businesses. As a result, the price will also increase on all goods produced within the US. In short, Americans will pay more and receive less.

This economic effect is known as inflation and its impact is particularly devastating to retirement and savings portfolios. This decline in the US dollar means a reduction in the purchasing power of the dollar and a corresponding reduction in the standard of living for those who earn, spend and save US dollars. In short, a weaker dollar means that Americans will work harder for less.

What is going on with the US $?

In December of 2004, the dollar hit an all time low against the euro at $1.3667. This was down sharply from $1.20 in September of 2004. (Source: Associated Press MSNBC.com, December 30, 2004)

The Euro isn't the only currency rising against a falling dollar. The Australian dollar is trading at six month highs and the Japanese Yen is near its highest trading rate in 8 months. The Canadian Dollar has just moved to multiyear highs against the US currency. (Source: Jubak TheStreet.com, November 10, 2004)

Foreign investors are closely watching the huge US deficits in the federal budget and trade accounts. According to the Commerce Department the trade deficit of the USA was $618 billion in 2004. The Congressional Budget office projects a $400 billion budget deficit for 2005 and the current US national debt is nearly $7.7 trillion.

Budget deficit = spending more than tax revenues collected. Trade deficit = buying more imports than you sell exports. National debt = Accumulated deficits + accumulated off?budget surpluses

CRN 0503-1256

A major cause of the current deficit is the result of increased growth rates in the U.S. When the U.S. grows faster than other world economies, we consume far more goods and services from overseas than they consume from us. This creates the imbalance in our trade accounts that we are experiencing today.

We also need to be mindful of the effects that the flow of foreign investment dollars into the US has on our economy. The US markets had a larger return on capital than Europe or Japan for the last 20 years. Foreign governments such as China and Japan have also purchased large amounts of US Treasury securities as a reserve, in order to back their own currencies and guard against the dollar from falling too fast and hurting their economy.

Worldwide currency traders recognize these trends. And investors view the increased spending on the war in Iraq, the massive cuts in tax revenues and the possibility of Social Security privatization as signs that budget and trade deficits will continue to escalate.

What are the Professionals saying?

Bill Gross the managing director for PIMCO, one of the worlds largest fixed income managers said, "Real interest rates in the United States will have to be kept low". He goes on to say, "Too much debt in a finance-based economy precludes raising interest rates like we have in the past and while that keeps the patient/economy breathing; it leads to asset bubbles, potential inflation, and a declining currency over time." Bill Gross hints at a continued slide in the value of the dollar but the real question is: what does this mean?

There are three main schools of thought regarding America's current economic situation with respect to the falling dollar.

Reduction of the trade deficit perspective

Some experts say that the dollar's fall is good because it makes US exports less expensive and that higher demand will cut the trade deficit. This group also contends that global financial markets are awash in so much money that the US can borrow much more than seemed possible 20 years ago.

The dollar may decline in value, according to this view, but the decline would be gradual and would help reduce American trade imbalances by making exports cheaper and imports more expensive.

The Bush administration goes one step further, arguing that America's huge foreign debt simply reflects the eagerness of others to invest here.

"Productivity has been remarkably high in the last few years," said John Taylor, deputy secretary of the treasury at a recent conference. "Foreigners want to invest in the United States. That's what the gap illustrates."

International investor perspective

A second school of thought holds that foreign governments like China and Japan will continue to finance American borrowing and keep the dollar strong because they are determined to sustain their exports and create jobs.

International investors own $1.9 trillion of the $3.8 trillion of marketable U.S. Treasury securities. (Source: Gilbert Bloomberg.com, November 17, 2004)

Possible Dollar collapse perspective

A third school, which includes officials at the International Monetary Fund, worries about a collapse in the dollar that would send shock waves through the global economy.

Former U.S. Treasury secretary Robert Rubin warned last November that the dollar's recent decline could accelerate and interest rates could rise if politicians in Washington don't act quickly to narrow the federal budget deficit.

Alan Greenspan speaking at a banking conference in Frankfurt on November 19th, 2004 said: "Anyone who has not appropriately hedged his position by now is obviously desirous of losing money". He went on to say, "Net claims against residents of the united states cannot continue to increase forever in international portfolios at their recent pace." And in his now famous enigmatic fashion he dropped the bomb, "Continued financing even of today's current account deficits as a percentage of GDP doubtless will, at some future point, increase shares of dollar claims in investor portfolios to levels that imply an unacceptable amount of concentration risk."

A steep drop in the dollar could lead to higher interest rates for the federal government and American private borrowers, as foreign investors demand higher interest rates to compensate them for higher risk.

Legendary investors hedge their bets

Savvy investors from all walks of life are taking this opportunity to diversify their portfolios and hedge their US Dollar bets. According to Forbes Warren Buffet owns 20% of the world's silver, Bill Gates owns 10-20% of Pan American Silver mines, and George Soros also has holdings in gold and silver mines.

What can you do about it?

You've heard the old investment adage, "Don't put all of your eggs in one basket." This is a good time to be reminded that a well-diversified portfolio should be the core of any well-planned investment strategy. And the construction of a well diversified portfolio begins within the framework of Modern Portfolio Theory.

Modern Portfolio Theory is the philosophical opposite of traditional stock picking. It is the creation of two economists William Sharpe and Harry Markowitz who won the 1990 Nobel Prize in economics for their work. Their quest was to try to understand the market as a whole. Investments are described statistically, in terms of their anticipated long-term return rate and their expected short-term volatility. The volatility is equated with "risk", and it measures how much worse than average an investment's bad years are likely to be. The goal is to identify your acceptable level of risk tolerance, and then to design a portfolio with the maximum potential return for that level of risk

Remember, no single type of investment performs best under all economic conditions. A diversified program is capable of weathering varying economic cycles and helps to improve the trade-off between risk of loss and expected return. Of course, diversification helps to reduce risk but cannot entirely eliminate the risk of investment losses.

Most experts recommend analyzing investment portfolios at least once per year. By identifying weaknesses and making adjustments, you can help ensure that your portfolio is performing efficiently.

According to an often-cited and time tested study* held in high regard by many professional investment managers, more than 90% of investment success is due to asset allocation rather than stock selection or any other strategy. This means that investors who carefully allocate their assets among a variety of asset classes (cash, bonds, stocks, etc.) have a greater potential of lowering their overall investment and market risk than those who invest only in one asset class. It is one of the key factors in the investment planning process. (*Source: Brinson, Singer & Beebower Financial Analysts Journal, May-June 1991)

Bottom line is that wise investors don't try to second-guess the financial markets. They take a structured, disciplined approach to investing that recognizes that market declines inevitably will occur. The overall strategic composition of a portfolio will not change unless the investor's situation changes substantially. However, you can use the periodic portfolio reviews to make tactical adjustments depending on prevailing economic conditions. One of the best ways to prepare for economic uncertainty is to have a well diversified portfolio in place and a plan to ensure that it maintains a high probability of helping you reach your goals.

Christopher T. Lawson, financial planner, is a registered representative of Lincoln Financial Advisors Corp., a broker/dealer. Investment advisory services offered through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor, 31111 Agoura Road Suite 200 Westlake Village, CA 91361 (818)-540-6916.

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results.

Mr. Lawson has over 11 years experience providing sound financial advice to Corporate pension plans and affluent families. He is a financial Planner with Sagemark Consulting and has presented at regional and national conferences for the following companies: Linsco/Private Ledger, American Express Financial Advisors, Associated Securities, TD Waterhouse Securities, and World Marketing Alliance. He has also worked with Merrill Lynch, UBS PaineWebber, Salomon Smith Barney (CitiGroup), and American Skandia (a Prudential Company).

---

Short Term Savings Products

When you invest, it simply means that you are putting... Read More

The Dreaded Direct Question

(Please have a glass of water within reach before reading... Read More

How to Choose the Right Share Class

You'll want to opt for the no-load or institutional share... Read More

Mutual Fund Returns May Not Be As They Seem!

Arthur Levitt, during his tenure at the SEC, experienced many... Read More

How to Setup a Profitable Trading Business

In my opinion trading is the most exciting and best... Read More

Angel Investors: Who They Are & When Are They Appropriate

Angel investors are individuals who invest in emerging business ventures.... Read More

Well Managed Investing Risks Bring Rewards!

"Risk comes from not knowing what you're doing!" Warren Buffett... Read More

Are You An Investment Dummy Like Me?

I am good at a few things. I can certainly... Read More

Eight Questions to Ask Your Financial Advisor

You may like your financial advisor, but is he really... Read More

Almost Anyone Can Open A Roth IRA!

The Roth is kind of weird until you get used... Read More

For Entrepreneurs A SIMPLE Plan May Be Best

Q: I own a small decorating business and I'll be... Read More

Asset Allocation: Critical to Your Investment Success

Asset allocation is a critical component of investing success. Both... Read More

A Gadfly On A Dinosaurs Butt, Or The Hood-winking Of The American Investor

Have you ever noticed how some words in the English... Read More

Investment Rowing

You have rowed a boat at some time haven't you?... Read More

Types of Investment

The word 'investments' is one that most of us are... Read More

Trading Expert Discovers Ways To Beat Stock Market Odds With Money Management

The first point to mastering money management is that you... Read More

The Economys Greatest Depression Downturn Ever Is Now Just A Few Years Away

What really controls the economy? Forget interest rates, forget deficits,... Read More

Profitability And Stock Turn Rate

The inventory of the typical store represents the largest single... Read More

Going Offshore For Asset Protection

There are a number of key reasons why individuals and... Read More

Choosing A Financial Advisor

With so many financial advisors trying to woo you with... Read More

An Economical Retirement Investment Plan

The practice of economy, directed toward a retirement investment plan... Read More

Help with My Annuity

The cries are heard from the distance, "I need help... Read More

An Investment Real Estate Strategy Unknown To Most Is A Negative Amortization Loan

If you want to make the most of your personal... Read More

Is a SEP Plan Right For Your Business

A SEP is a special type of IRA. Under a... Read More

Getting Started Investing is Often the Hardest Part

There are several reasons people give for not investing their... Read More

Margin Benefits are Marginal at Best

Margin is one of those things that novices find puzzling... Read More

Retirement Plan Considerations Cheat Sheet for Small Business

RETIREMENT PLAN CONSIDERATIONS are something every small business person needs... Read More

Expand Your Pool of Investors for Your Company

If you own a company that sells complicated products and... Read More

Your Portfolio and ?Old Ironsides?

The USS Constitution first ventured into the waters in 1798.... Read More

Sell Discipline for Investors: Importance and Execution

Investors usually don't have an aversion to buying an asset.... Read More

Trading Tips No 7: Developing a Casino Mentality for the Day Trader

I submit that the successful day trader would profit well... Read More

Annuity Investment - The Whole Truth

Do you ever feel like you haven't been told the... Read More

Investing and Understanding What You Buy

"There is nothing more frightful than ignorance in action!" Johann... Read More