Currency-Hedged ETFs: When Do You Need Them?
International ETFs carry currency risk. Hedged ETFs remove it — but at a cost. Here is when hedging makes sense.
Don't have time? Here's what you need to know:
- 1Currency-hedged ETFs neutralize exchange rate effects on international stock returns
- 2Hedging costs 2-3% per year when U.S. interest rates exceed foreign rates
- 3For long-term investors (10+ years), unhedged international ETFs (VXUS) are generally better
- 4Currency effects tend to wash out over 20+ year holding periods — hedging adds cost without long-term benefit
How Currency Movements Affect Your International ETF
When you buy VXUS, your money is converted from dollars to euros, yen, pounds, and other currencies to buy foreign stocks. If those currencies weaken against the dollar, your returns decrease — even if the foreign stocks rose in their local currency. In 2022, a strong dollar reduced VXUS returns by roughly 7-10 percentage points.
Currency-hedged ETFs use forward contracts to neutralize this exchange rate effect. HEFA (iShares Currency Hedged EAFE) holds the same international developed-market stocks as EFA but hedges out the currency exposure. Your returns reflect only the stock performance, not currency movements.
The Cost and Trade-offs of Currency Hedging
Hedging is not free. The cost equals roughly the interest rate differential between the U.S. and the foreign country. When U.S. rates are higher than foreign rates (as in 2023-2024), hedging costs 2-3% per year. When rates are similar, the cost is minimal. This cost directly reduces your returns.
Over long periods (20+ years), currency effects tend to wash out — some years the dollar strengthens (hurting unhedged returns), other years it weakens (boosting them). Academic research suggests that for long-term buy-and-hold investors, currency hedging adds cost without improving risk-adjusted returns.
| Factor | Unhedged (VXUS) | Hedged (HEFA) |
|---|---|---|
| Currency exposure | Yes — returns affected by USD strength/weakness | No — currency risk neutralized |
| Hedging cost | None | 2-3% when U.S. rates are higher |
| Long-term impact | Currency effects tend to cancel over 20+ years | Ongoing cost drag reduces returns |
| Best for | Long-term holders (10+ years) | Short-term holdings or strong USD view |
| Expense ratio | 0.07% | 0.35% |
When Currency Hedging Makes Sense
Hedge when: you have a short time horizon (under 5 years) for your international allocation, you have a strong conviction the dollar will continue strengthening, or your international allocation is large enough (30%+ of portfolio) that currency swings meaningfully affect your total returns.
Do not hedge when: you are a long-term investor (10+ years), you want the natural diversification that different currencies provide, or the hedging cost (2-3%) significantly exceeds any expected currency benefit.
Tip: Most financial advisors recommend unhedged international ETFs for long-term investors. The currency diversification is actually a benefit — it reduces your dependence on the U.S. dollar's purchasing power.
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Frequently Asked Questions
Does VXUS have currency risk?
Yes. VXUS is unhedged. If the dollar strengthens 5%, VXUS returns are reduced by approximately 5% (all else equal). Over long periods, currency effects average out. Over short periods, they can significantly impact returns.
Is HEFA better than EFA?
Depends on your time horizon and view. When the dollar is strengthening, HEFA outperforms. When the dollar weakens, EFA outperforms. Over 20+ years, the difference is small and EFA (unhedged) avoids the annual hedging cost.
Can I hedge currency risk myself?
Technically yes, through currency futures or options. But it is expensive and complex for individual investors. If you want hedging, use a currency-hedged ETF like HEFA — the fund handles the mechanics for you.
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Alex Harrington
CFA Level II Candidate, Finance & Economics
Alex Harrington is an independent ETF researcher and personal finance writer with over 8 years of experience analyzing exchange-traded funds. A CFA Level II candidate with a background in economics, Alex has reviewed 800+ ETFs and helped thousands of beginners build their first investment portfolios through clear, jargon-free education.
This content is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future results. Consult a licensed financial advisor before making investment decisions.