You will be able to calculate how a currency move changes the return on a foreign asset measured in Singapore dollars.
Farhan checks his world fund at the end of the year. The factsheet says it returned 8% in US dollars. His brokerage app, which shows everything in Singapore dollars, says he made about 2.6%. He assumes something is wrong with the app, or with the fees, and spends an evening looking for a charge he cannot find.
Nothing is wrong. The difference is the exchange rate, and once you can work it out yourself, a number like that stops being a mystery.
When you hold a fund priced in a foreign currency, your result in Singapore dollars depends on two things: what the fund did in its own currency, and what that currency did against the Singapore dollar over the same period.
The exact way to combine them is to multiply. Add 1 to the fund's return, add 1 to the currency's move against the Singapore dollar, multiply the two, then subtract 1. A quick estimate is to add the two percentages, which works well when both are small and drifts when they are large, the same way the shortcut for real return did in How money works, lesson 4.2, Real return is roughly the nominal return minus inflation.
Here are made-up figures. At the start of the year, one US dollar costs S$1.35. Farhan puts S$10,000 into his world fund, which buys about US$7,407 of units.
Over the year, the fund rises 8% in US dollars, so his holding is worth about US$8,000. Meanwhile the US dollar falls 5% against the Singapore dollar, so one US dollar now buys only about S$1.2825. Converted back, his US$8,000 is worth S$10,260.
His return in Singapore dollars is 2.6%. The formula gives the same answer: 1.08 times 0.95 is 1.026, and subtracting 1 leaves 0.026. The quick estimate, 8% minus 5%, says 3%, which is close but a little high.
Now run the same fund through two other made-up years. If the US dollar is flat against the Singapore dollar, Farhan's return in Singapore dollars is the full 8%. If the US dollar rises 5%, it is 1.08 times 1.05, minus 1, which is 13.4%. Same fund, same 8% return in its own currency, and three very different results on his screen: 2.6%, 8% and 13.4%.
The move works in both directions. A weaker Singapore dollar adds to your foreign returns, and a stronger one takes away from them. Neither is good or bad in itself. It is a second source of ups and downs layered on top of the first.
For shares, the currency effect can dominate a single year, as Farhan's three years show. Over long periods, it matters less than people fear. Exchange rates between major currencies tend to swing back and forth rather than move one way forever, so some of the good years and bad years cancel out. And the companies in a world index earn money in many currencies, which spreads the effect further.
That does not mean currency never matters over the long run. One currency can drift against another for many years. But compared with the swings in share prices themselves, which can be 30% or more in a bad year, currency is usually a smaller part of the long-term result for a share investor.
Bonds are different, and the difference shapes the hedging decision in lesson 5.3, Hedged share classes: when they help.
You hold high-quality bonds for steadiness, as lesson 1.2, What shares, bonds and cash each do in a portfolio, explained. Their returns in their own currency are usually modest. Currency moves are not. Made-up example: a US dollar bond fund returns 3% in a year while the US dollar falls 6% against the Singapore dollar. In Singapore dollars, that is 1.03 times 0.94, minus 1, which is about minus 3.2%. The bond part of your portfolio, the part meant to be calm, has lost money purely because of the exchange rate.
That is why currency is a much bigger question for the bond part of your portfolio than for the share part. A currency swing that is noise next to a share fund's movements can be larger than the entire return of a bond fund, and it can arrive in the same year your shares are falling.
Farhan finds the 5% move in the US dollar on the MAS website, which publishes exchange rate data, and his evening's mystery is solved. Your own three-year table in the activity uses the same multiplication. Write the formula once at the top of the page, and every row becomes a two-second calculation.
Using made-up figures, work out your SGD return on a USD fund for three years with different currency moves.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).