One of the more interesting problems youll face as you amass more capital is how to approach the issue of foreign currency income, either in the form of dividends, interest, rents, or capital gains.  You can solve this problem by reminding yourself that, ultimately, money exists to be used either by yourself, your heirs, or the charity of your choosing so the question really comes down to, How can a person extract the most utility out of his income when it arrives in a fiat not native to the country in which he or she resides?

Generally there are two things you can do with the foreign currency thrown off from your non-domestic holdings, presuming the country in which the asset is located hasnt imposed currency restrictions that prohibit moving the money out of the borders (this does happen from time to time, even in advanced economies; e.g. Great Britain in the aftermath of World War II).

Path I: Immediately Convert All Cash Flows Back to Your Home Currency When Received

The first course of action is to immediately convert all money generated by your foreign assets back to your home country and spend, reinvest, save, or donate it as you would any other source of income, accepting the volatility as part and parcel of the trade-off of owning foreign assets.  For most investors, given the ease, simplicity, and low cost of doing this at the time of distribution, its probably the best way to behave.  In the United States, this is what happens naturally whenever you own mutual funds, index funds, exchange traded funds, ADR/ADS, or foreign shares listed directly on an American exchange.

Imagine you are a 65 year old retiree in the United States.  You have no debt.  You have a portfolio worth $1,000,000, of which you have $250,000 invested in the Vanguard Total International Stock Index Fund Admiral Shares, ticker symbol VTIAX.  This fund runs at a mutual fund expense ratio of only 0.14% and holds 5,798 stocks, with 8.4% of net assets in the top 10 companies: Nestle, Royal Dutch Shell, Novartis, Roche Holdings, HSBC, Toyota, BHP Billiton, BP, Samsung, and Total.  You dont want to deal with Francs, Pound Sterling, Euros, Yen, and Won.  You just want to be able to go buy your groceries at the corner store, in U.S. dollars, paid for by your dividends.  Vanguard does it all for you.  You dont have to worry about the currency translations because they move all of the income back to U.S. dollars before paying those dollars out to the owners.  Over the past twelve months, youve collected a 3.37% distribution yield.  Some years it will be up, some years it will be down, you just accept it as part of your overall diversification plan.

I think that is the wisest for most families because a majority of people need that money to fund their lifestyle.  You pay your water, housing, sewer, and medical bills in your home currency.  You go to the local movie theater in your home currency.  You buy clothes in your home currency.  If its part of a well-structured portfolio, over time, the ups and downs of exchange relationships will probably average out (though there is no guarantee of this) so some years, youll get favorable currency movements, some years, unfavorable currency movements, but you should always have more cash coming into the Treasury, which is what counts.  If youre living without a lot of financial risk, have little or no debt, and a fortress-like balance sheet, who cares?

Path II: Maintain Pools of Wealth in Multiple Currencies Throughout the World

The developed world has become so interconnected that it is nearly effortless, with very little cost, to open a global trading account.  A discount broker such as Charles Schwab, E-Trade, or Interactive Brokers will allow you to do this and hold balances in multiple other markets and currencies.  You open it like any other brokerage account and can move money between currencies in exchange for a fee depending upon the amount you are exchanging at any given time.  Interactive Brokers, by way of example, allows you to hold balances in the following currencies:

• Australian Dollar
• British Pound
• Canadian Dollar
• Chinese Offshore Renminbi
• Czech Koruna
• Danish Krone
• Euro
• Hong Kong Dollar
• Hungarian Forint
• Indian Rupee* (Only for customers in India)
• Japanese Yen
• Mexican Peso
• Norwegian Krone
• New Zealand Dollar
• Russian Ruble
• Singapore Dollar
• Swedish Krona
• Swiss Franc
• United States Dollar

If you own shares of Nestle SA in Switzerland, rather than the ADR, the dividend will come in Swiss Francs, get deposited in your Swiss Franc balance, and sit there until you do something with it.  The exchange rate between it and your home country might be fluctuating wildly every day, but the you still own the same amount of CHF, sitting there, waiting to be reinvested in Switzerland, exchanged for something else, or spent.

At this point, you can either move the money back to your home country when it is most advantageous (e.g. your home country experiences a substantial decline relative to other currencies, giving you the opportunity to take advantage of it and capture more domestic funds its in your best interest) or, alternatively, if the currency rate is unfavorable and you want to use the money, why not take a trip?  Head to Zurich and spend the Swiss Francs somewhere on the Bahnhofstrasse.  Arbitrage the difference by spending your Swiss Francs on something you would have purchased, anyway, and then convert more of your home currency into Swiss Francs to replace the funds, taking advantage of the strength of your native fiat.  In some cases, youll end up with a lot more purchasing power than you would have if you moved your Swiss Francs back to your home currency and tried to go down to the local branch of the exact same store, buying the exact same product there.

The big question you have to ask yourself if you pursue this path is whether you want to hedge your currency exposure or not.

To Hedge or Not to Hedge: That Is the Question

Why, specifically, are you acquiring foreign assets?  Are you attempting to mitigate the risk of your own home country declining?  If so, you probably dont want to hedge your international holdings back to your native currency.  Is it because you want to diversify but still expect to repatriate that money at some point, spending it in your local community?  If so, hedging makes a lot of sense.

For most retail investors, hedging of international assets is done easily through intermediaries offering it as part and parcel of the financial product they are purchasing.  For example, a Canadian investor who wanted to own an S&P 500 index fund of American stocks might buy the iShares Core S&P 500 Index ETF (CAD-Hedged). ticker symbol XSP, as the portfolio is hedged back to the Canadian dollar to remove the effect of currency fluctuations between it and the United States dollar.

Likewise, an American investor who wanted to own Japanese stocks might pass on the iShares MSCI Japan ETF [symbol EWJ], which has no currency hedge, and instead buy the iShares Currency Hedge MSCI Japan ETF [symbol HEWJ] as it owns the former ETF plus offsetting currency hedges bought at the aggregate portfolio level.  He or she would be getting the exact same basket of stocks Toyota, Mitsubishi, Softbank, Honda, etc. but be agnostic on exchange rates, largely non-affected by them except to the extent they got out of control and the future price of hedging increased, cutting into returns.

Individual positions can be hedged by individual investors, but it makes little sense to do so unless you have a reason to think youll need to spend the money in the target currency (e.g. you have financial obligations in a currency that differs from your source of cash generation, such as building a vacation home in France, paid for in Euros, while you collect most of your money in Pounds Sterling from a portfolio of British dividend stocks).  The price of such effective insurance will depend upon a myriad of factors.  Currency hedging is far beyond the scope of our discussion, and it is not even remotely appropriate for a lot of people, but if youre interested in researching it, it could be achieved by utilizing either a future or an option.  In effect, if you owned a 500,000 CHF block of Nestle SA, you would acquire an offsetting currency position that was designed to inversely correlate by going short the currency (agreeing to deliver a set amount of Swiss Francs at a future date at a specified price and/or settling the difference in cash).  That is, if you were an American investor living in the United States, and the value of the Swiss Franc increased 10% relative to the U.S. dollar, the future or option would decline by 10% so you were in roughly the same position.  What you gain on one hand, you lose on the other, artificially keeping the exchange rates on parity for your own portfolio.  For most people, it would be easiest to go to a private bank and have them handle the transaction for a fee rather than trying to do it yourself even though it isnt as hard as it looks.

In my own life, I have had my immediate and extended family own hedged and non-hedged assets depending upon the circumstances.  My goal is to make the most intelligent, most tax-advantageous decision I can at any given time relative to my alternatives.  This is the reason its impossible to offer some blanket rule.  If youre worried about it, buy hedged index funds and leave it at that.  There is no right or wrong answer here, its personal risk management and accepting what will make you happiest in your own estates affairs.