Globalization and the internet have expanded investment opportunities. Depending on your investment appetite, you could invest in a German broad market index or tap into an authorized agent to acquire a United Kingdom government bond.
However, as we continually reiterate, all investments carry a degree of risk. And if your goal is to put your money into foreign financial instruments, you can add currency risk to the list of potential investment hazards.
Global Currencies, Investment Impacts
Currency risk, sometimes known as exchange-rate risk, is what international investors or companies face when the price of one currency increases in relation to another. Currency risk impacts investors and corporations that operate in different countries.
How does this impact your German broad market index or UK bond? Quite simply, if there are unexpected movements in the currency exchange rates such as the British Pound or Euro, it could erode any high returns from your investment. It could even lead to a loss. Fluctuations in a foreign exchange rate could have a negative impact on the value of your investment instrument.
Currency risk is also a type of foreign investment risk. If your investment is tied to the value of the country’s currency (rather than U.S. dollars), selling the investment and converting the proceeds into U.S. dollars, means the exchange rate determines your gain or loss.
Potential Risk-Management Strategies
Because of currency risk, there can be a higher degree of volatility and risk exposure if you direct your monies to foreign investment offerings. However, there are some options that might help manage that risk.
Select Strong Economic Countries
Consider investments in countries with strong, rising currencies (relative to the U.S. dollar) and relatively stable interest rates. The higher the foreign currency increases, the more it will be worth when exchanged to home-country dollars.
Diversify, Diversify, Diversify
It can be a good idea to diversify international currency holdings with other financial instruments. Such assets might spread risk across multiple currencies, countries, companies, or a combination of these. Some might contain American companies that generate profits from abroad, possibly hedging their own foreign currency risks.
The takeaway here is that foreign investments carry an added degree of risk due to currency fluctuations. This doesn’t mean such investments should be avoided. But when it comes to determining whether to add international assets to your portfolio, be sure to assess the additional risk as part of your due diligence. And if you have any questions or concerns, be sure to check with your financial advisor.
