Investing across borders and currencies

You’ve probably heard about the importance of diversifying your investments. In order to reduce risk and optimize your chances of achieving a positive return on your investments, you should avoid overinvesting in a single location, currency or sector. That way, national, political or economic changes and downturns won’t risk all your investments in just one shift.

However, investing across borders and currencies comes with some additional complexity. Specifically, if you have any investments based in a foreign country and currency, then you have to take the exchange rate into account when purchasing, monitoring or selling your investments to gain an accurate understanding of your investment.

There are two ways that this might affect your investments: you might have investments in a fund that finds its source in another country and currency; or you might trade directly in currencies in the foreign exchange (forex) market. Either way, exchange fluctuations in addition to the actual value of the stocks, if applicable, need to be taken into account.

As an American investor, your source or purchasing currency is the US dollar (USD), which is generally considered a strong currency. When purchasing stocks, their value may be listed in USD as an equivalent to the exchange rate in effect at the time of purchase, or in their original currency.

Keep in mind that values may not be exactly as displayed. Depending on how you make the payment, you may have a slightly different exchange rate, and you’ll probably have some amount of service fee added to the initial purchase price.

Currencies shift in relation to one another on a continuous basis. This is more intuitive in forex trading, but keep in mind that it has a bearing on all funds in foreign currencies. If you hold a fund in a foreign currency, then you need to factor in not only the change in value of that fund but also how the current exchange rate between its source currency and the USD impacts the value at the present time.

In other words, if you make an investment in the British pound sterling (GBP) and the pound grows stronger against the dollar over the course of your investment, then you will earn more on the trade. If the pound weakens against the dollar, then you will earn less.

On top of the exchange rate, you’ll want to consider how currency transfer fees would impact the sale of that fund when you convert it back from its source currency to USD. In effect, you’ll need to reduce earnings by the transfer fees and reduce or increase them based on the exchange rate.

As a general rule, longer investments are likely to provide stronger returns and even out the impact of currency fluctuations and transfer fees. For that reason, it’s better to plan on a longer investment period for forex or funds in foreign currency trading.

Reputable US-based financial media will frequently display results in USD based on the current exchange rates in effect, which simplifies things somewhat. The Hammerstone Group specializes in real-time results. In the case of current data converted to USD, all you have to do is factor in transfer fees to understand the value of your investments and guide your decision-making. Given the frequency of currency shifts, which change literally from one minute to the next, it’s dangerous to rely on out-of-date information.

As with all investing, your ideal situation is to buy low and sell high. This gains another dimension when dealing with funds in a foreign market. If possible, you want to purchase a fund at a low point at the same time as purchasing in a currency that is weak against the dollar but is likely to strengthen concurrently with the fund strengthening. This scenario would compound your gains, but of course it is a challenge to both find these opportunities and accurately predict the movement of both currency and sector-based markets.

At the moment, digital currencies or “cryptocurrencies” such as Bitcoin are another investment opportunity. They function in a similar manner to traditional foreign currency. There will be an exchange rate between any given cryptocurrency and the USD at all times, and it’s possible to both invest in the currency itself as a “foreign” currency, and, in some cases, purchase other types of funds with that currency. While projections for cryptocurrencies have been positive and shown some dramatic gains, keep in mind that these can be remarkably risky and hard to predict.

Foreign currencies dramatically impact your investment returns. They add some complexity, and you’ll need to consider both the exchange rates at the time of purchase and sale, as well as associated fees with transferring funds between the two currencies. In general, plan on longer-term investments to make the most of foreign currency funds.