Currency movements can influence investment results more than they may seem at first glance. If you are investing in foreign assets, it is worth understanding how the euro and dollar exchange rate can subtly change the value of your returns.

What Is Currency Risk

Currency risk arises when an investor invests in a currency other than the one they normally spend in or use to plan their financial goals. For a Slovak investor, this often means investing in U.S. assets denominated in dollars, while their home currency is the euro. As a result, the final outcome depends not only on the performance of the investment itself, but also on the EUR/USD exchange rate.

How the Euro and Dollar Exchange Rate Affects Returns

Let us imagine an investor who puts 1,000 euros into an ETF traded in dollars. They exchange euros for dollars, buy the fund, and after one year the ETF increases in value. However, the true result only becomes clear when the investment is converted back into euros. If the dollar has strengthened, the return may be even higher. If it has weakened, part of the gain may disappear. This simple example shows that in foreign investing, it is not only the ETF’s performance that matters, but also the exchange rate of the currency.

When Currency Risk Is a Bigger Problem and When It Is Smaller

The importance of currency risk depends on several factors. The investment horizon is especially important. In short-term investing, exchange rate fluctuations can have a more significant impact on the final result, while over the long term their effect is often reduced. The type of asset, the size of the exposure to a foreign currency, and the regularity of investing also play a role. An investor who invests gradually buys at different exchange rates, which naturally reduces the risk of poor timing (if you are interested in how gradual investing works in practice, you can read more about this topic in one of our previous articles).

Currency Risk in ETFs and Funds

With ETFs and funds, it is important to distinguish between currency-hedged and unhedged products. The label “currency hedged” means that the fund manager tries to limit the impact of exchange rate fluctuations. As a result, returns reflect the market’s performance more closely and currency movements less. However, this solution may increase costs. With unhedged funds, the investor bears the full currency risk. At the same time, it is also true that the fund’s trading currency does not automatically mean that currency risk disappears. What matters most are the underlying assets.

Can Currency Risk Be Reduced?

Currency risk cannot always be eliminated completely, but it can be reduced. Diversification across different regions and currencies, regular investing, and a longer investment horizon can all help (if you are interested in how to approach investment allocation in practice, you can read more about this topic in one of our previous articles). In some cases, choosing currency-hedged products may also make sense. For the average investor, however, the most important thing is to understand currency risk and take it into account appropriately, rather than trying to eliminate it at all costs.

The Most Common Mistakes Investors Make

A common mistake is focusing only on the return of the asset without considering the result after converting it into the investor’s home currency. Another misconception is the belief that a fund traded in euros automatically means there is no currency risk, even though the underlying assets may still be linked to the dollar or other foreign currencies. Investors also often panic unnecessarily during short-term exchange rate fluctuations or automatically assume that currency hedging is always better. In practice, however, it depends on the investor’s goals, time horizon, and the product’s costs.

What to Focus On When Investing in Foreign Assets

Before investing in foreign assets, it is useful to ask yourself a few questions: In which currency will I need the money in the future? Am I investing for a few years or for decades? Do I understand which currency I am actually exposed to? And do I want to accept currency fluctuations, or would I rather limit them? The answers to these questions help investors make more thoughtful decisions.

Currency Risk in Perspective

When investing abroad, it is not only the performance of the stock, ETF, or fund that matters, but also the development of the currency. Currency risk should therefore not be ignored, but neither should it be feared automatically. What matters is understanding how it works and how it fits into an overall investment strategy. An investor who understands this can look at their returns more realistically and with greater perspective.

For more investment trends and useful tips, take a look at our previous articles on the AxilAcademy website.