2026-02-21

How Currency Exchange Rates Affect Your Investment Returns

If you invest in anything denominated in a foreign currency, your return is not what the stock chart says. It is not what your broker shows on the position page. Your real return — the number that actually matters — is the return in the currency you spend.

This is the most misunderstood aspect of international investing. A stock can go up 15% and still lose you money. An ETF can drop 5% and still make you a profit. The difference is the exchange rate, and it acts as an invisible multiplier (or divider) on every foreign-currency investment you hold.

This guide explains exactly how currency movements affect your investment returns, with formulas and concrete numbers, so you can calculate your real returns and make informed decisions about currency exposure.

The Basic Mechanics

When you invest in a foreign-currency asset, your total return has two components:

  1. Asset return — how much the investment gained or lost in its local currency
  2. Currency return — how much the foreign currency gained or lost against your home currency

Your total return in your home currency is approximately the sum of these two, plus a small cross-term:

Total return (home currency) = Asset return + Currency return + (Asset return x Currency return)

The cross-term is usually small and sometimes ignored in rough calculations, but it matters for precision.

Example 1: Currency Amplifies Your Gain

You are a USD investor. You buy a UK stock at GBP 100 when GBP/USD is 1.25.

Your cost in USD: GBP 100 x 1.25 = USD 125

Six months later, the stock is at GBP 112 (up 12%), and GBP/USD has risen to 1.30 (GBP strengthened 4% against USD).

Your value in USD: GBP 112 x 1.30 = USD 145.60

Your total return in USD: (145.60 - 125) / 125 = 16.5%

Breakdown: - Asset return: +12% - Currency return: +4% - Cross-term: 12% x 4% = +0.5% - Total: 12% + 4% + 0.5% = 16.5%

The currency movement added 4.5 percentage points to your return. You did not plan for this. You did not hedge for it. It just happened because the pound strengthened while you held the investment.

Example 2: Currency Erases Your Gain

Same scenario, but now GBP weakens. You buy at GBP 100 when GBP/USD is 1.25.

Your cost in USD: USD 125

Six months later, the stock is at GBP 110 (up 10%), but GBP/USD has dropped to 1.15 (GBP weakened 8% against USD).

Your value in USD: GBP 110 x 1.15 = USD 126.50

Your total return in USD: (126.50 - 125) / 125 = 1.2%

Breakdown: - Asset return: +10% - Currency return: -8% - Cross-term: 10% x (-8%) = -0.8% - Total: 10% + (-8%) + (-0.8%) = 1.2%

Your stock gained 10% in local terms. You made 1.2% in reality. The 8% currency decline wiped out almost all of your gain.

Example 3: Currency Turns a Gain Into a Loss

You buy a Japanese stock at JPY 10,000 when USD/JPY is 130 (so your cost is USD 76.92).

The stock rises to JPY 10,800 (up 8%). But USD/JPY moves to 150 (the yen weakened significantly against USD).

Your value in USD: JPY 10,800 / 150 = USD 72.00

Your total return in USD: (72.00 - 76.92) / 76.92 = -6.4%

The stock went up 8% in yen. You lost 6.4% in dollars. This is not a hypothetical — between 2022 and 2024, the yen fell roughly 30% against the dollar, and USD-based investors in Japanese stocks saw significant FX drag despite strong local-currency performance of the Nikkei 225.

Example 4: Currency Turns a Loss Into a Gain

You are a GBP investor who bought a US stock at USD 50 when GBP/USD was 1.35 (your cost: GBP 37.04).

The stock falls to USD 48 (down 4%). But GBP/USD drops to 1.22 (dollar strengthened against pound).

Your value in GBP: USD 48 / 1.22 = GBP 39.34

Your total return in GBP: (39.34 - 37.04) / 37.04 = +6.2%

Your stock lost money. You made money. The dollar’s strength against the pound more than offset the decline in the stock price. British investors with US holdings during 2022 experienced exactly this dynamic as the pound weakened sharply.

The Formula for Real Returns

For any foreign-currency investment, the precise formula for your home-currency return is:

Home currency return = (1 + Asset return) x (1 + Currency return) - 1

Where: - Asset return = (End price in local currency - Start price in local currency) / Start price in local currency - Currency return = (End exchange rate - Start exchange rate) / Start exchange rate - Exchange rate is expressed as units of home currency per unit of foreign currency (e.g., for a USD investor holding EUR assets, use EUR/USD)

Let us apply this to a concrete scenario.

You are an AUD investor holding a US stock. The stock goes from USD 200 to USD 220 (asset return = 10%). During the same period, AUD/USD goes from 0.65 to 0.62 (meaning the USD strengthened against AUD).

To calculate: you need USD in terms of AUD. If AUD/USD goes from 0.65 to 0.62, then 1 USD goes from 1/0.65 = AUD 1.538 to 1/0.62 = AUD 1.613.

Your stock gained 10% in USD. You made 15.4% in AUD because the US dollar strengthened against the Australian dollar during your holding period.

How FX Drag Compounds Over Time

The examples above cover single holding periods. Over multiple years, FX effects compound — and this is where they become truly significant.

Consider a USD investor holding a European equity ETF for five years. Each year, the ETF returns 8% in EUR terms (hypothetically constant for simplicity). But the EUR/USD rate moves each year:

Year ETF Return (EUR) EUR/USD Change Return (USD)
1 +8% -3% +4.8%
2 +8% -2% +5.8%
3 +8% +1% +9.1%
4 +8% -4% +3.7%
5 +8% +2% +10.2%

Cumulative EUR return: 46.9% (compound of five 8% years) Cumulative USD return: 38.2% (compound of the USD returns)

The EUR weakened a net 6% over five years, and that FX drag reduced your cumulative return by 8.7 percentage points. On a USD 100,000 investment, that is USD 8,700 in returns you never received — not because of poor stock picking, but because of currency.

Measuring FX Impact on Your Portfolio

To understand how FX is affecting your portfolio right now, you need to calculate two numbers for each foreign-currency position:

  1. Local return — the performance in the asset’s native currency
  2. Home currency return — the performance converted to your home currency

The difference between them is your currency impact. If a position returned 12% in local terms and 7% in your home currency, currency cost you 5 percentage points on that position.

Doing this manually for every position, with accurate historical FX rates, is tedious. It requires recording the exchange rate at the time of each purchase and comparing it to the current rate.

FlashFi tracks the FX rate at the time of each transaction and shows you returns in your home currency. Your portfolio dashboard gives you the consolidated view — how to set this up is covered in our multi-currency tracking guide.

Currency-Hedged Funds: Removing the FX Variable

If you want exposure to foreign equities without taking on currency risk, currency-hedged ETFs are the main tool available to retail investors.

A currency-hedged fund uses forward contracts to neutralize the exchange rate effect. In theory, the return of a hedged international equity fund approximates the local-currency return of the underlying stocks — the FX component is stripped out.

How Hedging Works

A USD-hedged European equity ETF: 1. Holds European stocks denominated in EUR 2. Simultaneously enters into forward contracts to sell EUR and buy USD 3. Rolls these contracts regularly (typically monthly) 4. Your return approximates the EUR performance of the stocks, regardless of EUR/USD movement

When to Use Hedged Funds

Shorter time horizons (1-5 years). Over shorter periods, FX volatility can dominate equity returns. If you are investing money you will need in 3 years, hedging removes the unpredictable FX component.

When you have a strong view on the currency. If you believe the EUR will weaken against the USD over the next few years, a hedged European equity fund lets you capture European stock returns without the expected currency drag.

When FX volatility is high. During periods of monetary policy divergence (e.g., the Fed hiking while the ECB holds steady), FX movements can be large and sustained. Hedging during these periods can preserve returns.

When Not to Hedge

Longer time horizons (10+ years). Over very long periods, research from Vanguard and others suggests that currency effects tend to wash out. Hedging has a cost, and over decades, that cost may exceed the benefit.

When hedging is expensive. The cost of hedging is driven by the interest rate differential between the two currencies. When US rates are significantly higher than foreign rates, hedging foreign currency exposure for a USD investor is relatively cheap (you earn the rate differential). When the situation reverses, hedging becomes expensive.

As of early 2026, with US rates moderating and other central banks at varying levels, the cost of hedging depends heavily on the specific pair. The interest rate differential between the US and Japan remains wide, making JPY hedging expensive. The USD/EUR differential has narrowed, making EUR hedging cheaper.

When you want the currency diversification. Sometimes the whole point is to have foreign currency exposure. Hedging a position defeats that purpose.

For USD investors: - HEDJ — WisdomTree Europe Hedged Equity Fund (EUR hedged to USD) - DXJ — WisdomTree Japan Hedged Equity Fund (JPY hedged to USD) - DBEF — Xtrackers MSCI EAFE Hedged Equity ETF (broad international, hedged to USD) - DBEM — Xtrackers MSCI Emerging Markets Hedged Equity ETF

For GBP investors, iShares offers GBP-hedged versions of many of its core ETFs on the London Stock Exchange.

For AUD, EUR, and CAD investors, similar products exist from Vanguard, iShares, and others.

Note: US expats should be aware that non-US domiciled ETFs (including currency-hedged ones listed on European exchanges) may be classified as PFICs. See How to Invest as a US Expat (PFIC Rules Explained) for the implications.

Strategies for Managing Currency Impact

Strategy 1: Accept It (Unhedged Global Diversification)

Buy a globally diversified portfolio and accept the FX volatility as part of the package. Over 20-30 year horizons, the academic evidence suggests currency effects are largely noise around the equity return signal.

This is the simplest approach and appropriate for long-term investors who do not need the money soon and can tolerate year-to-year fluctuations.

Strategy 2: Hedge Selectively

Hedge the positions where you have concentrated currency exposure, and leave the rest unhedged. If 30% of your portfolio is in JPY-denominated assets and you are concerned about yen weakness, hedge that portion. Leave your 10% EUR and 5% GBP positions unhedged because they are smaller and the cost of hedging each individually is not worth it.

Strategy 3: Natural Hedging

If you earn in USD and your expenses are in EUR, investing in EUR-denominated assets creates a natural hedge. If the EUR strengthens (making your expenses more costly), your EUR investments also become worth more in USD terms, partially offsetting the higher living costs.

This is particularly relevant for expats and digital nomads. If you live in Spain or Germany and spend in EUR, EUR-denominated investments provide a natural buffer against EUR strength. See How to Build a Multi-Currency Investment Portfolio for detailed allocation strategies.

Strategy 4: Cash Buffer in Spending Currency

Maintain 6-12 months of living expenses in your spending currency. This gives you a buffer that decouples your daily life from short-term FX movements. If the exchange rate spikes against you, you can wait it out rather than being forced to convert at an unfavorable rate.

For someone living in Costa Rica or Indonesia, keeping a local-currency cash buffer means you are not checking exchange rates every time you pay rent.

Monitoring FX Impact Over Time

The key to managing currency risk is visibility. You need to be able to see, at a glance:

Without this visibility, you are making portfolio decisions with incomplete information. You might think your Japanese equity position is outperforming, when in reality, yen weakness has eroded the gains. You might sell a European position that looks flat in your home currency, not realizing the underlying stocks performed well and the apparent underperformance was entirely due to EUR weakness.

Track Your Real Returns

FlashFi converts every position to your home currency using live exchange rates, so you always see the number that matters — your real return in the currency you spend. No manual calculations, no stale FX data, no guessing how much of your return was the stock and how much was the currency.

Start tracking your real returns with FlashFi and see how currency is actually affecting your portfolio.

By David Brougham