How to Cash In (or Not) on Currency Exposure
A globetrotting portfolio could have an impact on your bottom line.
Question: I've been hearing a lot about how the dollar is headed down. How could these movements affect my international investments' returns?
Answer: International travelers know that when they go abroad, they will have to exchange U.S. dollars for other currencies before they can hop in a taxi or pay cash at a restaurant. The same holds true for buying stocks on a foreign exchange, or doing so indirectly via a foreign mutual or exchange-traded fund. Before U.S. investors can buy shares of a foreign stock, they must first trade in their dollars for the foreign currency in which the security is denominated. And when they sell the stock, they'll receive the proceeds in the foreign currency, which they must then exchange for dollars. Appreciation or depreciation in that foreign currency over the time they've held the stock might affect returns--sometimes for the better, sometimes for the worse.
How Do Currency Fluctuations Work?
The value of one currency relative to another can fluctuate for a variety of reasons--the interplay between the countries' trade balances, fiscal and monetary policies, rates of economic growth, and inflation, to name some of the key ones. Foreign currency exposure can be beneficial as part of a well-diversified portfolio because it adds another layer of diversification, much like being diversified across stocks of different sizes and styles.