International investing has the potential reward of diversification, but it is coupled with additional risks. Over the last decade, the foreign market underperformed, while the U.S. market was strong. The tide may be turning. Proceed with caution, however.
There are risks in every investment, including cash. Most investors focus on one risk, which is the loss of principal in the moment. There are many risks we must consider as fiduciaries. Inflation, market, sector, credit, interest rate, business, regulatory are some but not all of the risks associated with investing. We will be doing a video series on these risks on our Facebook group page Financial Enhancement Group Financial Tidbits.
Foreign investment brings additional risks. Notably are currency risk and political risk. Bear in mind the above risks are also included. There is comfort in knowing your investments, which is often difficult in a foreign environment. Currency risk is the most misunderstood concept for most retail investors.
Similar to a stock, the value of a currency is what another buyer is willing to pay for it. In the case of foreign currency, the price is driven by substantial institutions. For instance, there may be a manufacturer in the U.S. with plants in China, Germany, or Japan. They need to reduce their exposure to currency risk and use institutions to buy and sell various currencies to mitigate that risk.
Foreign governments also enter the currency markets to stabilize their economy when possible. Two issues that commonly confuse onlookers: “Joe, how can a currency have risk?” “Joe, why wouldn’t a government always want a strong currency?”
Currency has no immediate risk for an individual unless you travel outside of your country. There are long-term risks for all citizens. You can live your entire life in the United States and never cross a foreign border – even to our largest trading partner, Canada. A dollar bill in Indiana is worth the same in New York, but a coffee and hotel stay is likely to be more expensive. You still understand the cost.
People in Germany maybe in three countries regularly – Germany, Switzerland, and France. The reason the Euro currency was created was, in large part, to reduce the complexity of price change in multiple currencies. Currency fluctuation could make something cheaper in one country and more expensive in another. By the way, Switzerland doesn’t play that game and retains its own currency.
If you are an exporter of goods to other countries, a weak currency is beneficial. Notice our President is always talking about our dollar being too strong. If you are primarily an importer of goods from foreign countries, you want a strong currency so you can buy cheaper. Sobering nations try to find the right balance, but market forces continue to drive the valuation.
The fluctuation of currency values has been of great magnitude recently. Foreign investing needs to be understood, but start with learning about how currency changes impact your nest egg.
Disclaimer: Joseph Clark is a Certified Financial Planner™ and the Managing Partner of Financial Enhancement Group, LLC an SEC Registered Investment Advisor. He is the host of “Consider This” found on WIBC Saturday mornings from 6-7a.m. as well as three other Indiana-based radio stations. Joe has served as an Adjunct Assistant Professor at Purdue University where he taught the capstone course for a degree in Financial Counseling and Planning.
Financial Enhancement Group is an SEC Registered Investment Advisor. Securities offered through World Equity Group, Inc., Member FINRA/SIPC, and a Registered Investment Advisor. Investment Advisory services offered through Financial Enhancement Group (FEG) or World Equity Group. FEG is not owned or controlled by World Equity Group.
Joseph Clark and World Equity Group, Inc. do not provide tax or legal advice. For tax advice consult with a qualified tax professional. For legal advice consult with an attorney