When 7 is Less than 4
When the Japanese Nikkei gained 7.2% during January and the NASDAQ gained 4.1%, you are mistaken when you think that the Nikkei would have made you more money. Yes, you are reading this right. In this case 7.2% is not more but less than 4.1%. I will explain.
To be able to see how 7.2% can be less than 4.1%, you have to take into account the currency that the stock market index is nominated in. The value of the NASDAQ is measured in U.S. Dollars. The value of the Japanese Nikkei index is measured in Japanese Yen.
Thus during January, the NASDAQ gained 4.1% measured in U.S. Dollars. And the Nikkei gained 7.2% measured in Japanese Yen.
Now, when you are a U.S. citizen, you probably calculate your wealth in Dollars and not in Yen. Thus, you are more interested to see how much your investment in the Nikkei gained measured in Dollars. And you do not care so much about how much it gained in Yen. And yes, the gains in Dollars and Yen are not the same; they are different.
Be Aware of the Currency
The reason why the gains of the Nikkei in Dollars differ from the gains in Yen is because of changes in the U.S. Dollar – Japanese Yen currency exchange rate.
At the end of December, one U.S. Dollar could buy you 86 Japanese Yen. At the end of January, one Dollar was worth 91 Yen. Thus, if you invested at the end of December in the Nikkei, you got 86 Yen for every Dollar. But when you would have sold at the end of January your Japanese Nikkei fund, you would have to pay 91 Yen and not 86 Yen for every Dollar that you wanted to get back.
During January the Japanese Yen lost 6% of its value versus the Dollar. That means that your investments in Japanese stocks would have to gain during the same period more than 6% measured in Yen, for you to make a profit.
The Nikkei gained 7.2% during January. And since this is more than the 6% decline in the value of the Yen, you would have made a profit during January. To be exact, the Nikkei gained 1.2% during January when measured in U.S. Dollars. Compare this to the 4.1% of the NASDAQ. Do you see now how “7.2%” can be less than 4.1%?
The conclusion is that as an American investor, you could have made more money during January by being invested in a NASDAQ index fund than in a NIKKEI index fund. And the same is valid for a Japanese investor. Because the 4.2% gains in the NASDAQ in Dollar terms translates to a whopping 10.2% gain when you calculate it in Yen.
The purpose of this blog post is not to discourage you from making investments is index funds for foreign markets. Investing in foreign markets can offer you with better diversification and better returns. However, it is more complex than it may seem at a first glance. When investing internationally 4.1% is sometimes more than 7.2%.