Key Principles Related to Foreign Currency Movements
Investors shouldn't make investment decisions based on expectations of
future foreign currency movements. Here are four key reasons why:
1. It is almost impossible to predict the timing of currency
movements.
Predicting when a particular currency may rise or fall is a very difficult task.
In fact, Allan Greenspan, former chairman of the
U.S. Federal Reserve, once likened the probability of accurately forecasting
short-term exchange rates to that of a coin toss. Speaking in November 2004
he said,
"Despite extensive efforts on the part of analysts, to my knowledge,
no model projecting directional movements in exchange rates is significantly
superior to tossing a coin."
2. The impact of currency movements tends to diminish over
time.
While exchange rates fluctuate from year to year, the impact of currency
on investment returns declines consistently over time. As highlighted
previously, over longer time periods currency movements have very little
impact on performance.
3. In a diversified portfolio, the currency movements tend to
even out.
A well-diversified portfolio has exposure to many different currencies.
For example, global mutual funds will typically hold securities from the
U.S., Europe and Asia-all denominated in different currencies (i.e. $US,
Euro and Yen). Often a rise in one currency is offset by a decline in
another. The interplay between baskets of currencies is sometimes
referred to as a natural hedge. The
RBC O'Shaughnessy International
Equity Fund and the RBC Global Titans Equity Fund
are examples of funds
that invest across multiple currencies, providing natural offsets against
exchange rate fluctuations.
4. There's little reward for betting on currency over the long
term.
Currencies can fluctuate more in value than the stock market. Over time,
investors are simply not rewarded for currency fluctuations the same way
they are rewarded in the stock market. The long-term trend for the markets
is up.
Learn more about the impact of currency movements and exchange rates on your investments:
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