Currency exposure, or not

You buy American shares with your euros. They rise ten per cent in the year. And yet, you lose money.

How? Over the same year, say the dollar lost ten per cent against the euro.

Your ten thousand euros gain ten per cent in dollars, then lose ten per cent on the exchange. You are left with nine thousand nine hundred euros.

When you buy a foreign investment, you buy two things: the investment, and the currency it is priced in.

Currency hedging is there to cancel the second. You keep the investment, you neutralise the currency.

In practice, you commit to selling your dollars later, at a price set today. What the dollar does meanwhile no longer matters.

With a perfect hedge, your year would have given roughly the shares' ten per cent. Minus the cost of the hedge.

Because it has a cost. It depends mainly on the gap between the two currencies' interest rates.

Say five per cent in the United States, three per cent in the euro area. Hedging then costs about two per cent a year.

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Many ETFs come in a hedged version. Same shares, same index, minus the currency. And this cost, built in.

Two per cent a year, over twenty years, is not nothing. Ten thousand euros at seven per cent become thirty-eight thousand six hundred and ninety-seven euros.

At five per cent, twenty-six thousand five hundred and thirty-three. More than twelve thousand euros apart.

Yet over a long period, currencies go up and down. Their swings tend to partly cancel out.

The hedging cost does not cancel out. It comes back every year, as long as the rate gap lasts.

That is why, over a long horizon, currency often matters less than you think. It makes noise, not necessarily losses.

Careful, the rate gap can also reverse. Depending on the year, hedging costs, or earns a little.

So when should you hedge? The right question is not where you invest. It is where you will spend.

You live in euros and are buying a home in two years? Say a fifty thousand euro deposit, invested in American shares.

A fifteen per cent fall in the dollar would cost you seven thousand five hundred euros of deposit. Over two years, that risk really matters.

And for a two-year project, shares are not the right place anyway. Hedged or not.

A retirement in euros in thirty years? The exchange rate weighs less, and the hedging cost piles up for a long time.

The rule fits in one line: hedge into the currency of your life, for money you will soon spend.