Investing in US markets
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8. Currency factors
One of the risks UK investors take when they invest in US stocks and bonds is currency risk.
Specifically, your gains and losses (in sterling) will be influenced not just by the price movement of the stocks you invest in, but also by the way in which the value of the dollar moves relative to sterling.
This simple example shows how:
- You invest £10,000 in a US dollar account with a US broker at an exchange rate of £1= $1.50. Your £10,000 is worth $15,000.
- You shrewdly invest the $15,000 in a stock that goes up 20%. Your $15,000 has become $18,000.
- In the meantime, however, the value of the dollar relative to the £ has fallen. £1 now buys $1.65.
- At the new exchange rate, the $18,000 current value of your investment is worth £10,909 in sterling terms.
- In other words, after allowing for currency movements, your gain has been cut from 20% to a less impressive 9.09% .
This sounds dramatic and high risk, but there are three mitigating factors:
- It works both ways. If the value of the dollar increases against sterling, your gains will be magnified.
- It is probably not worth trying to anticipate currency movements. Professional investors devote staggering amounts of time and money to betting on currencies. Sometimes they are spectacularly right, but they are just as often badly wrong. It's foolhardy to go up against them.
- Currency changes only affect you if you actually convert your dollars back into sterling. If you leave them in your dollar account for reinvestment or spending, they make no difference.
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