WTF Wall Street Word: Do I Need To “Currency Hedge” My Investments Errr What’s That?

fascinating

Le’ts do this.

What is this “currency hedge” topic everyone is talking about? 

If you live in the U.S. and you buy a stock fund that invests in the stock of U.S. companies, the fund is denominated in U.S. dollars. That makes perfect sense.

So in this example, a U.S. stock fund buys the stock of U.S. companies in U.S. dollars. Fine.

But what if you want to buy a stock fund that invests in the stock of European companies?

You can buy U.S. dollar denominated stock fund that invests in the stock of European companies. Ok that sounds straightforward. But what happens if the euro depreciates in value relative to the U.S. dollar?

dollar vs. euro. ouch

That line that is declining over the last year means that you get fewer U.S. dollars for your euros. One euro is buying you fewer and fewer dollars.

Back to your U.S. dollar denominated european stock fund investment.

While the european stock fund you invest in is U.S. dollar denominated, if the value of the euro tanks relative to the USD over the course of your investment, you (the fund) still need your money back in U.S. dollars, because you live in the U.S., right?

So if the euro went down in value, it is going to cost you (the fund you’re invested in) more to convert your money back to dollars i.e. one euro buys fewer  U.S. dollars.

How do you avoid exposure to currencies tanking in other countries where you have investments? 

There are funds that “currency hedge” their investments. When a fund currency hedges their exposure to say, the fluctuating euro, they buy investments that move in the opposite direction of the currency they are trying to get away from. So if the euro goes down, this investment (hedge) goes up, ideally minimizing currency losses.

In 2014, U.S. denominated stock funds that invest in european stocks that “currency hedged” their portfolio significantly outperformed those that did not. We’re talking about a difference in performance of around -5% vs +5% for some funds.

Ok great. But now what? 

The U.S. dollar has been on a tear relative to most currencies. The rest of the world’s major economies have been reducing interest rates (which should depreciate their currency further relative to the U.S. dollar) and China just announced they’re doing a “one-time” devaluation their currency.

It’s good to remember this when you’re investing in funds where you have some currency exposure, particularly if it’s for a short-term investment. We talk about all this type of news in The MSB Cheat Sheet.

If you’re not a MSB Cheat Sheet member yet…we want you. Get The MSB Cheat Sheet. Join the freeloaders society of America—> here.

Premium MSB Cheat Sheet members, log in here to see your “sample investment fund list” you have access to. We include a few funds that currency hedge their investments.