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FP Article 15.4 (To sign up for a FREE 16-lesson eCourse on Investment Risk, please click here.)

Investment Risk - Currency Risk

by Rajen Devadason

There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.  

John Maynard Keynes

  Our planet is getting smaller and more connected each day.

It makes sense, therefore, that an increasing number of us invest not just domestically in our own home country but also abroad.

The main advantage of doing so is wider access to great investments.

The main disadvantage is currency risk.

Let me explain it in simple terms.

 

 

 

 

 

 

 



As many visitors to this site know, I live in sunny Malaysia, which sits just a smidgeon above the equator. In a recent study on global happiness, Malaysia ranked 17 out of about 200 countries, ahead of the US and the UK.

But though my country may sit higher on the happiness index than those two major nations, which I understand reasonably well for having lived and worked in them, I recognise Malaysia is on a lower economic rung than them.

I might hypothetically, therefore, decide I will invest in the US to diversify my portfolio.

The moment I do so, I expose myself to currency risk. If the foreign exchange (or forex) movements go against me, I might end up with less in my base currency than I started off with even if the investment went up in target currency terms.

This is an article explaining currency risk. I hope you enjoy reading it. But if it isn't what you're looking for, you're welcome to search for something that better meets your needs. Thank you for allowing me to serve you.

Rajen Devadason

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If you're looking for an official definition, then note that currency risk can be defined as the risk taken on by anyone who invests in anything denominated in a currency apart from his own, because of the possibility of capital loss through unfavourable forex fluctuations.

That's why I advise my clients - the vast majority of whom live in Malaysia and plan to retire there - to make sure the bulk of their investment assets are denominated in the Malaysian currency, which is called the ringgit and shown as RM.

Only after my clients have reached a significant level of savings and investments, does it make sound sense to invest abroad and thus expose themselves to currency risk.

Consider this example:

Let's say I bought some greenback notes (US currency) a couple of years ago and paid RM3.80 for US$1. Then a few years from now I wake up one day to find the ringgit trades at RM3.00 to the greenback.

I am now stuck with American dollar bills that are worth 21% less, in RM terms.

Such an extreme example shows what might go wrong. Of course, things can also happily go the other way.

So, what you need to first ask yourself is whether your base currency (your home country's currency) has been sliding against major currencies over the last 20 or 30 years.

If it has, you might decide on taking on some currency risk to allow you access to other strengthening currencies.

John Maynard Keynes - the Father of Keynesian Economics - warned : "There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

The lesson is clear: Pay attention to currency movements.

If you'd like to continue to learn more about other types of investment risk, here's additional information for you...

15 Types of Investment Risk (OR, to sign up for a FREE 16-lesson eCourse on Investment Risk, please click here.)

1. Borrowing Risk

2. Company Risk

3. Credit Risk

4. Currency Risk

5. Diversification Risk

6. Industry Risk

7. Inflation Risk

8. Interest Rate Risk

9. Liquidity Risk

10. Lost Opportunity Risk

11. Manager's Risk

12. Market Risk

13. Market Timing Risk

14. Political Risk

15. Prepayment Risk

 

 

© Rajen Devadason

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Rajen Devadason, CEO RD WealthCreation Sdn Bhd & RD Book Projects
349, Desa Rasah, Jalan Bayan 7, 70300 Seremban, NS, Malaysia
Tel/Fax: +606 632 8955

 
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