FP Article 15.4
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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
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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.
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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
