Lately, a number of readers have been asking me whether it’s worth holding onto their U.S.-stock holdings if the U.S. dollar keeps falling. Some wonder if they should follow their brokers’ suggestions and hedge against the risk of a drop in the U.S. dollar, using options, futures or other investment products.

If you knew that the U.S. dollar would keep falling, the best portfolio management strategy would be to sell all of your U.S. stocks and buy them back when the dollar stabilizes. However, you don’t know where the U.S./Canada exchange rate is going next — you never do.

The financial industry has a variety of products that can insulate your U.S. investments from a drop in the value of the U.S. dollar. These products obviously cost you money. In addition, they reduce the long-term value of your U.S. investments. After all, you invest in U.S. stocks for two key reasons. One is that the U.S. stock market offers certain types of investment opportunities that are rare or non-existent in Canada, such as giant multi-national consumer companies like Procter & Gamble or McDonalds. The other key reason for U.S. investment is that it gives you currency diversification. That’s crucial to a sound portfolio management strategy.

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U.S. dollar could rebound

I’m not convinced that the U.S. dollar will continue to fall. The Canadian dollar has risen from under $0.80 U.S. in January to about $0.87 today. That’s partly due to a rise in commodity prices, particularly oil. But it’s hard to imagine that commodity prices will get anywhere near their 2008 highs this year, or even in 2010. So, a continued rise in our dollar (or a fall in the U.S. dollar against the Canadian dollar) seems unlikely, because of our relatively greater economic dependence on resource industries, compared to the U.S.

If you could predict short-term currency fluctuations, you could quickly acquire a measurable proportion of all the money in the world. Nobody ever does that.

Rather than try to predict and profit from exchange rate fluctuations, I plan to continue to maintain a reasonable portion (30% or so) of my portfolio management clients’ funds in well-established U.S. companies like the ones we recommend in Wall Street Stock Forecaster.

I don’t make any attempt to hedge against the risk of depreciation in the U.S. dollar with my portfolio management clients. Hedging might reduce short-term volatility, but it’s also likely to cut long-term profitability.

I advise you to do the same when looking after your portfolio. If you don’t want to accept the risk of U.S. dollar depreciation, my advice is to reduce your U.S. dollar holdings.