The Currency Effect in International Investing

Chart of the Week for July 21-27, 2006

The chart on the right shows returns of the MSCI EAFE Index, which tracks developed international stock markets, in both local currency and US dollar terms. When investing abroad, US investors buy securities in another country’s currency, so fluctuations in exchange rates can have a significant effect on returns.

As we can see in the chart, currency exchange rates have had a positive effect on returns (in US dollar terms) over shorter time periods. The highest difference of 6% in the five-year period coincides with the weakening trend of the dollar in the past five years. The chart on the left shows that the US Dollar Index, an index designed to track the dollar's performance against other major currencies, has been declining from a peak of about 120 in 2001 to 85 in June 2006. However, over a 10-year period, the returns of the MSCI EAFE Index in local currency and US dollars are almost same. This is because the US dollar’s exchange rate against other major currencies reverted back to about the same level as 10 years ago.

Investors are benefiting from the dollar’s recent weakening trend. However, we should keep in mind the negative impact of currency on international investment during 1996 to 2001, when the dollar strengthened against other currencies. Over the long-term, currency fluctuations smooth out. Investors in international markets are actually facing risks from both market volatility and currency fluctuation; it’s important for investors to keep a long-term focus and diversified portfolio to reduce risk.

This illustration was compiled by information from outside sources. These companies are not affiliated with ICMA-RC. This information is being provided for educational purposes and is not intended to be construed as or relied upon as investment advice. ICMA-RC does not offer specific tax or legal advice. Individuals are advised to consider any new investment strategies carefully prior to implementing.

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