The short answer is yes.
Foreign exchange matters.
Two reasons:
- It costs money to exchange money
- It exposes you to risk in currency movements
Consider this:
When you buy stocks in another country, you need to purchase the stocks in their currency.
For example, say you live in NZ but want to buy stock in Microsoft.
You will first need to exchange your NZD into USD before investing.
If you're using Sharesies, they will charge you a 0.5% fee for the exchange.
That means your potential returns have already taken a 0.5% hit.
You are also now exposed to potential losses from movements in the exchange rate.
This is known as foreign exchange risk.
For example, if your Microsoft stock goes up by 5%, but the exchange rate moves against you by 10%, you will actually lose money even though the value of your stocks went up!
Let's look at an example of how this might happen:
Say the price of Microsoft stock is $200 USD, and you want to invest.
The exchange rate is 0.65 (65c USD for $1 NZD)
This means one Microsoft stock is $308 NZD.
You exchange your NZD at 0.65 and make the investment.
Microsoft has a great year and goes up to $220 USD - a 10% gain. Nice!
But let's say the NZD/USD exchange rate rose to 0.75 during that time.
Even though your MSFT stock is worth $220 USD, due to the exchange rate rising it's worth only $293 in NZD. And you paid $308 NZD for it.
Even though your stocks rose 10% in value, in NZD terms, your portfolio is actually down $15 due to your foreign exchange exposure.
The reason this happens is because when you invest in foreign stock markets you expose yourself to two risks:
- Stock market risk
- Foreign currency risk
The good news is you can mitigate these risks over a long time span.
How To Minimise Foreign Exchange Risk When Investing In Stocks
As long as you do not exchange large currency amounts at extreme tops and bottoms, or you dollar cost average your investments, you can reduce the volatility forex might cause in a portfolio.
Historical averages can help. Take a look at the chart below:
Header | NZD / AUD | NZD / USD |
|---|---|---|
Current Rate | 0.941 | 0.641 |
5 year average | 0.937 | 0.684 |
10 year average | 0.910 | 0.728 |
20 year average | 0.880 | 0.692 |
30 year average | 0.853 | 0.648 |
We can see the NZD is currently below the 5, 10, 20 and 30 year average for AUD.
This means it's currently a great time to buy AUD judging by historical trends.
On the other hand, the NZD weaker against the average USD rate on all time frames. This tells you today is not an ideal time to be buying USD, and it might be wise to hold off buying USD stocks unless prices are at absolute no-brainer levels.
Ways you can manage your forex risk
- If you know you're going to be buying US or AU stocks, be proactive and exchange USD or AUD when the rates are better than historical averages. This should give you some comfort that over the long term, your downside is protected.
- Dollar cost average (invest at regular intervals) so your exchange rate averages out over the long term.
- Invest in "hedged" funds or ETFs that actively hedge to minimise volatility from exchange rates.
- If in doubt, stick to investing only in the NZ market (or your local market).
When It Can Be An Advantage To Have Forex Exposure
In some cases, investing in foreign stock markets is actually a legitimate way to diversify the risks in your portfolio
The idea is that holding a portfolio in three currencies can be "safer" than one.
Think about it this way:
When a currency weakens, it always weakens against another currency.
For example, if the NZD is getting weaker, that also means the USD is getting stronger.
Having exposure to multiple currencies means you are constantly hedging yourself against movements in the forex market.
One reason this is advantageous is because the NZD is a relatively small currency by global standards. Some would even consider it insignificant.
If all the NZD in the world disappeared tomorrow, many countries wouldn't even blink.
Therefore, have your portfolio exposed to other currencies is a good way to diversify your risk.
Since your savings are in NZD, and your salary is being paid in NZD, and your house is valued in NZD, and your Kiwisaver is in NZD, some would say you are overexposed to NZD.
Having a stock portfolio that is heavy in US and Australian stocks means you have now diversified some of that overexposure away.
If the NZD ever had a disastrous period where it plummeted in value, you would be hedged with your allocation of AUD and USD denominated stocks.
As you can see, foreign exchange definitely matters in investing, but the risk that comes from foreign exchange isn't always a negative. Used wisely, it can actually make your portfolio much more resilient.
Happy investing!
