My wife and I took a cruise through Europe in the fall of 2013 along the Mediterranean. As we arrived at different ports and visited various cities along the sea, I was floored by how little my dollar went overseas. With a foreign exchange (FX) rate of about $1.40/€, enjoying a €5 gelato while walking the streets of Florence was a $7 experience. Secretly, I hoped to return overseas at a different time when my dollar would go further.
Fast forward to the end of 2016 and the Euro is trading near a 14-year low relative to the USD. Next time I visit Europe I can have the satisfaction of knowing my dollar can go 25% further. It’s almost like everything there is on a 25%-off sale. My $4,500 budget for spending onshore can go as far as $6,000 went in 2013, and I can purchase some gelato at $5.25 instead of the $7 it originally cost and the local vendor is none the wiser.
However, while tourists dream of seeing the value of their dollar go further overseas, that doesn’t come without a price.
However, while tourists dream of seeing the value of their dollar go further overseas, that doesn’t come without a price. As it turns out, U.S. Investors are exposed to one extra layer of risk when investing internationally: Currency risk. Currency risk is risk that arises from changes in the relative valuation of currencies. So as you order gelato in Italy at 25% off in USD, you will also be “enjoying” that same lower 25% value of your international stock holdings of, say, BP, Nestle, or Novartis.
Reality Check on International Exposure
As I logged into my 401k account, I reviewed my year-end balances for 2016. With most major indices worldwide up 10% for 2016, such as the UK Stock Market FTSE 100 (+~17%), Japan’s Nikkei (+~7%) and German DAX (+~11.5%), I expected to see my international exposure up about 10%. What did I find instead? My international holdings were up only 3% for the year! If the funds in my account are designed to be made up of stocks in these international indices that have been up nearly double digits, why were my returns not following along?
