If you invest in international stocks, ETFs, or funds, you are exposed to more than just the performance of those companies. You are also exposed to changes in currency exchange rates. This is called currency risk.
How Currency Risk Works
When you buy an international investment, your US dollars are converted to the local currency. When you sell, the local currency is converted back to US dollars. If the exchange rate changed during that time, it affects your return.
Example: You invest $10,000 in a Japanese stock fund. During the year, the fund gains 10% in Japanese yen. But the yen weakened 5% against the dollar during the same period. Your return in US dollars is roughly 5%, not 10%.
The reverse can also happen: if the foreign currency strengthens, your returns get a boost.
When Currency Risk Helps
If you invest in a foreign market and that country's currency strengthens against the dollar, you get a double benefit: the investment gains PLUS the currency appreciation.
This is one reason international investments can provide diversification. When the US dollar is weakening (which reduces the purchasing power of your US-based savings), your international investments denominated in stronger currencies gain value in dollar terms.
When Currency Risk Hurts
If the US dollar strengthens significantly, international investments lose value in dollar terms even if the underlying assets performed well in their local currency.
This happened to many international investors between 2011 and 2016 when the US dollar strengthened substantially.
How to Manage It
Diversification is the main tool. Owning investments across multiple currencies reduces the impact of any single currency movement.
Hedged funds exist. Some international ETFs offer "currency-hedged" versions that attempt to neutralize the currency impact. These add cost but remove currency volatility.
Long-term perspective. Over very long periods (20+ years), currency fluctuations tend to average out. The shorter your time horizon, the more currency risk matters.
Understand your exposure. Many US large-cap companies earn 40-50% of their revenue internationally. Even if you only own US stocks, you have some indirect currency exposure through the companies' foreign operations.
The Bottom Line
Currency risk is an unavoidable part of international investing. It adds an extra layer of uncertainty but also an extra layer of diversification. For most long-term investors, the benefits of international diversification outweigh the currency risk.
The Progressive Trailblazer integrates economic data from multiple sources. Educational only. Not financial advice.