Fluctuations in exchange rates can have a surprisingly large impact on the investment return for a domestic investor. If you buy an investment that goes up by 10 percent but the home currency declined by 12 percent compared with the dollar, you’ll have a loss on the books rather than a gain.
Studies have indicated that rising equity markets tend to be associated with rising local currencies, leading to even larger gains in the dollar-denominated return. It isn’t remotely a perfect relationship, however.
A rapidly rising dollar isn’t an issue if you solely invest in domestic equities. But it could mean that all your foreign holdings will return you fewer dollars or pay smaller dollar-denominated dividends. The same holds true in reverse: If the dollar is falling in relation to the currencies of your foreign holdings, you’ll receive more dollars when you sell your foreign stock.
If the stocks have also appreciated in terms of their home currency, you’ll see even more gains in your portfolio statement.