Theres a world of difference between investing in international assets and domestic markets, with the single biggest variable underpinned by currency fluctuations.
For example, when a UK investor purchases stock in a domestic firm, the primary variable in play is the potential change in share price. However, while this remains an important factor in international investments, the value of assets held overseas are vulnerable to other factors including real-time currency shifts.
In this post, well ask how such currency fluctuations affect the value of a portfolio, while appraising the impact of fx exchanges when buying and selling foreign shares.
How do Currency Fluctuations Affect the Value of a Portfolio
On a fundamental level, currency fluctuations and real exchange rates have always impacted on the wider economy, and by association the international corporations that operate across borders.
This means that every aspect of an individual company can be affected by quantitative easing measures (such as slashing the base interest rate) and forex prices, including earnings, costs, margins and their underlying operational incentives.
So, if youre a UK investor whose portfolio includes several international stocks and equities, it also stands to reason that currency fluctuations will also impact the value of your holdings in real-time.
Lets say that youre and American who owns stock in a Japanese firm, with each share worth 5,000 yen and the exchange rate between this currency and the dollar fixed at 100 yen per greenback.
If we divide the local share price by the exchange rate, we see that each share is worth $50. Now, lets say that while the shares of the firm rose by 20% over the course of the next six months, the exchange rate also increased to 120 yen per dollar.
In this instance, the process of dividing the local share price by the exchange rate yields exactly the same result as before, meaning that the value of your investment has remained unchanged as a direct result of fluctuating currency prices.
If we extend this logic, of course, its also easy to see how your investment could be devalued as part of this process, undermining your wider portfolio in the process.
How to Thrive and What are the Key Takeaways?
This conundrum is further exacerbated by the volatile nature of the forex market, in which currency prices can deviate wildly from their average within relatively short periods of time.
This is particularly true during periods of peak demand and liquidity, where volatility peaks and individual prices can rise and fall without warning.
Clearly, timing is key when executing stock trades and orders, as youll want to factor in the real-time exchange rate for the relevant currency pair while understanding the likely trajectory of this asset in the future.
Its also important to note that currency fluctuations can cause the value of your portfolio to increase, especially when the value of your domestic currency appreciates against the relevant overseas asset.
So, changes in portfolio performance and your annualised returns may prove positive over time, so you may want to capitalise on this type of opportunity going forward.