When we buy a stock from a foreign country it is usual that the currency used is different from our own, unless you live in a common currency area like the European Union.
If you are doing short-term trading this is not a big issue.
If we buy a stock and sell it in a month time there is normally no problem associated with the currency exchange rate. However, if there is a crash in a particular currency we may face several losses or profits, depending on what side we were.
Normally people do not count on these matters.
In most cases the changes in the currency rate will not affect our strategy in the short-term in a decisive way.
Example of Forex influence in stock investing
For instance, there could be the case of some Spanish investor who bought American stocks in 2002 and sold them in 2004. In that case the Spanish investor lost some money despite the fact that stocks did not fall those years (see the chart at the begginning).
In fact, it was quite a bad investment since the euro rose a whopping 35% against the dollar.
The loss would have been that 35% minus the dividends.
Although things could have changed a lot if we had analyzed it over a longer period of time.
We should not be carried away by short-term emotions.
When we discuss long-term investing two years is not a big deal.
As we can see, even major currencies like the euro and dollar can have significant variations that affect the purchasing power of their own citizens.
What would happen then with weaker currencies?
Obviously, you can expect major moves, especially in the currencies of those countries that do not still belong to the First World.
Although there is one factor to take into account: normally when a country’s currency fall a lot its stock market rise.
Should we cover our risk when we invest in foreign stocks?
The truth is that I do not think we should do this since when we do this, we have to incur in additional costs.
When we invest in foreign stocks we should do focusing in the long-term and thinking in the macro scenario of the trade.
As I said before, if we buy Brazilian stocks and the Real depreciates a 50% the next 10 years, it is very likely that its stock market will perform better than the European markets. Though this does not necessarily need to be true.
In general, when we buy foreign stocks there will be opportunities and risks.
Risks, because any country can do very badly and try to adopt socialist policies, like the case of Venezuela in the second decade of the 2,000.
Opportunities, because some developing countries have a lot of potential if they do things more or less well, which in general means that they pursue a policy that supports private property.
Everything has its positive and negative face.
The best thing we can do to avoid this king of risks is to diversify as much as possible.
There you have the answer to the original question.
Diversify in foreign stocks
A good diversification polity is to buy different stocks in our national stock market and also international ones.
Doing so we would be covering the regional risk besides the sector risk.
The best example of recent years is Venezuela. The money was worth there by 1.990 but was worth nothing in 2015.
For instance, a Venezuela family could have the equivalent of 200,000 dollars invested in stocks in 2000.
If half of those stocks were invested in foreign stocks, like those of the United States, the Venezuelan citizen would have saved a great deal of his capital. What is more, he or she would have had money to use in case of emigrating.
The citizen who had all the investments in Venezuelan bonds and stocks lost most of its purchasing power.
The question is that if we use a strategy that diversifies in different stocks of the major countries like United States, Europe, Japan, Australia, etcetera, it is a very safe portfolio.
Some of those countries will have better and worse results, but in general thing would compensate.
So with this way of diversifying we are actually taking more currency risk, but at the same time we are reducing overall risk.
There is a lot of risk being 100% exposed to the same economy.
Therefore, we should not be afraid of investing in other currencies.
When we invest in an asset, whether national or international, we do because we like that particular asset; because we see a good future with it. If we proceed this way we should not be afraid of the currency risk or any other because we will have a very good diversified portfolio.
The most important this is, therefore, choose good stocks, buy them at interesting prices and diversify.
The rest is secondary.