It seems that many currencies have been extremely volatile this year, case in point the pound. Within the space of the past 12 month, it has traded in the range of 0.65 – 0.82 to the US dollar. This is a massive 26% trading range! Whilst a wide trading rage might be normal for currencies of developing economies, it is very rare for the best currencies. And the GBP is not alone. Safe haven currencies like the the Japanese Yen and Swiss Franc have all traded in a wide range against the dollar. Yes you may say that the dollar has been volatile as opposed to the rest but as most investments is done by foreign buyers into the US market or by US investors into foreign markets, it is wise to use USD as a bench mark in this case.
How Currencies Affect Investing Returns
It is only natural for investors to think about currencies when investing internationally. Here is what happens if your currency appreciates or deprecates relative to the currency you bought your stock in.
If you buy stocks in a foreign market and subsequently your home currency appreciates, you lose out even if the equity you bought does not change in price. So if you were to sell the foreign stock for the same amount you bought it, you would have the same amount in foreign money but when you convert it back to your home currency you will have less. This is because your currency is now stronger or more expensive so you need more foreign currency than before to buy the same amount of your own currency.
Conversely, if your currency depreciates, you get an immediate capital gain on your holding even if the stock price stays constant on the foreign market.
So if you were to sell the foreign stock for the same amount you bought it, you would have the same amount in foreign money but when you convert it back to your home currency you will have more. This is because your currency is now weaker or cheaper so you need less currency than before to buy the same amount of your own currency.
The latter is what happened after the brexit vote this year. The Pound (GBP) depreciated 10% against the US Dollar (USD). Thus any any British person holding American stocks would have an immediate 10% capital gain.
So say you bought Johnson and Johnson (JNJ) stock the day before the Brexit vote. On that day JNJ stock price was $115 and the USDGBP rate was 0.67. So as a UK investor, JNJ stock cost you £77. After the Brexit vote, GBP depreciated 10% against the dollar meaning that the rate was now 0.74. On that same day JNJ was still trading at the exacts ams price of $115. So although JNJ did not change in price, the UK investor had gained 10% due to the currency move. If the investor sold his share for $115 and then converted that back into GBP, he would get £85. As his initial GBP purchase price was £77, that’s a 10% gain simply because his home currency got weaker.
So should worry about currencies when investing?
As you can see, if you get the currency right, there is serious money to be made. But I myself do not play this currency game. If you are not a professional investor, predicting rate movements is futile. Even traders whose job it is to make these predictions get it wrong most of the time. If you want to play the speculative currency game, you should join a platform like etoro. Currencies are a traders game and long-term investors should shy away from it.
Instead of predicting currency moves, do this.
As an individual investors, it is a waste of time trying to predict currency movements. It is far better and wiser to spend your time researching quality businesses. It is well advised to buy into these great businesses whose value you know will appreciate over time instead of guessing how a certain rate will move.
If you find a wonderful business that is trading at a decent valuation, no matter what your currency is doing right now, it is in your own interest to buy that stock.
The low value of GBP at the moment did not stop me from investing in US Biotech giant Gilead recently. Even though I know that the GBP is undervalued against the USD as compared to historical norms, I refuse to play the currency game.
The thing with internationally diversified companies is that no matter which way the currency moves, you will make money over time.
- If the GBP keeps getting weaker against the USD, my capital gain will increase as seen by the JNJ example above.
- If on the other hand the USD gets weaker, I still win. This is because the company conducts business overseas (outside the US) and thus generated revenues in foreign currency. So if the USD get weaker, it will be able to generate higher revenues and profits as it can now buy more dollars with its foreign earnings. Higher profits generally lead to increases in stock prices. Buying into an multinational business acts as a natural currency hedge for an investor.
So you see, it is pointless to think about currencies when making an investment decisions. It is far better to use your time to identify and understand wonderful business that generate revenue regardless of the macroeconomic climate.