How currency movements can affect your financial goals

There are several risks that you need to consider before investing your funds in various instruments. One aspect that is often overlooked by investors is currency risk. Here are some key factors to note to take informed decisions.

What is currency risk?

When there is a change in the value of one currency vis-à-vis another, there is an element of risk. So, in translation, you may not realise the full value of a transaction and lose a certain amount owing to the volatility in the movement of the currency.

How does it affect you?

Let us say, you plan a holiday to the US a few months down the line and the cost works out to $5000 and the exchange rate is Rs 68 to the dollar. But when you actually go down to doing the bookings, you find that the cost is still $5000, but the exchange rate has gone up to Rs 72. So, you need to shell out Rs 4 more for every dollar, or Rs 20000 more! For all purchases and spends that involve an international currency, there is an element of volatility and risk of loss involved.

Will my investment value be hit?

If you invest in an overseas theme, for example, the Motilal Oswal Nasdaq 100 Exchange Traded Fund, there are two components affecting overall returns. One is the actual performance of the ETF itself, in dollar terms. The second is the currency translation part. So, a weaker rupee will add to your returns. Gold’s value in India are also dependent on international prices of the yellow metal, and the exchange rate between the American dollar and Indian rupee.

Will the rupee always depreciate against the US dollar?

Over the long term, the Indian rupee has steadily depreciated against American dollar. Most of the times, it is assumed that the rupee will depreciate three per cent each year, while making your financial plans. However, you should note that there could be intermittent periods of rupee strengthening. For example, the rupee appreciated against US dollar from Rs 47.06 to Rs 39.01 over June 2006-November 2007.

Which other currency should I track?

It depends on your financial goals or assets and the currency in which the financial goals or assets are priced. For example, a vacation planned in the Eurozone should take into account the rupee-euro movement.

How do I protect my financial plan from adverse currency movements?

Businessmen and large investors usually hedge their currency exposure by using derivative instruments. For most individual investors, tracking currency movements itself can be of immense help. It is better to realign your investment plans, after factoring currency risk.

You can also consider investing in assets priced in a currency in which you are likely to incur your future expenses. For example, if you want to send your daughter to the US for higher education after ten years, it makes sense to invest some money in a mutual fund that invests in US equities. Education costs there would adjust to the prevailing inflation, interest rates and the state of the economy. Investing in the US will help fulfil this goal. You may also consider some allocation to gold exchange traded funds as a dollar-hedge.

Currency risk can make you fall short of achieving your financial goals.