Is investing in forex a good idea?

In this advice column Kathy Hull from The Wealth Corporation answers a question from a reader who wants to buy dollars to hedge against the weak currency.

Q: I have just opened a “Global” account with one of the big four local banks that allows me to invest in foreign currency. I am thinking of going straight into the dollar with a lump sum of R15 000. Thereafter I would like to invest some spare cash, which would be about R1,000 to R2,000 every alternate month, depending on the strength of the ringgit.

I am 30 years old with a diverse investment portfolio, including offshore unit trusts. I aim to keep this account for the long-term, with the aim of hedging myself against any weakness in the rand. Is this a good strategy?

It is refreshing to read that young South Africans are taking investing seriously and looking at all the options available when deciding where to invest their hard earned money. You should be commended for that.

With limited information on your financial affairs and your investment strategy going forward, there are a few things you do need to consider when making a decision on where best to invest your capital. I will discuss some of these below, although I won’t go into the potential tax implications of your decisions, which should also be a consideration.

As a starting point, you have to keep in mind that investment markets, including exchange rates, are volatile. It is therefore important to be anchored in your investment strategy and financial goals.

If you do not believe in your investment philosophy, your prospects for success diminish and you are at the mercy of emotion. Vital principles to consider are that risk and return are related; diversification is the antidote to uncertainty; asset allocation determines the rate of return in a diversified portfolio; and emotion undermines the best investment strategy.

In your case, you need to think carefully about why you want to buy dollars. Are you making an emotional decision based on the current exchange rate, or is there a long term strategy behind it?

When you make a call on an asset class, such as wanting to send rands offshore to hedge yourself against a weakening currency, you also need to understand what influences the asset class you are investing in. To understand the factors that sway the currency is complex to say the least, however, taking time to learn more about the following factors (to name but a few) could help with your decision:

• The current account, including terms of trade – a current account deficit would contribute to a weaker rand.
• Inflation – a country with a lower inflation rate has a stronger currency as its purchasing power increases relative to other currencies. Countries with a higher inflation could experience a depreciation of their currency.
• Interest rates – there is a correlation between inflation, interest rates and exchange rates. A higher interest rate could attract foreign investment which will cause the currency to strengthen.
• Political and economic stability – a healthy country on both levels will attract foreign investment and vice versa.

When purchasing forex, you also need to understand your financial position and plan. This includes your risk tolerance, the time when you will require your saved capital, where you intend to retire, and your expected rate of return.

If you want to send funds offshore because you plan to live and retire abroad in the future, then the exchange rate plays less of a role when considering return, as you will not be converting the funds back to rands. If this is the case, then you rather need to consider other factors such as the real return on your offshore investments and the inflation rate internationally. If you are just buying dollars and letting them sit in a bank account, the value of your money may actually be depreciating.

Even if you will be bringing the money back into South Africa, this should be a consideration. Simply put, if you are going to be buying dollars, why not invest those dollars into asset classes with higher yields than cash? That way you not only hedge against the rand, but also earn returns in hard currency.

Another factor that you highlight is that with any offshore strategy you ideally want to purchase forex when the rand is strong against the purchasing currency. However, you do need to understand the high risk in making currency calls. Trying to time markets and currencies is very rarely, if ever, a good idea.

I take you back to 2001 where the rand depreciated from R7.60 in January 2001 to R13.84 in December 2001 against the dollar. By mid-2007, it had recovered back to around R6.50 to the dollar.

If you had bought dollars at even R13 when it seemed that there was no way back for the local currency, it would have taken until this year for you to see that rate of exchange again.

Once again, this emphasises the importance of not making emotional decisions. When you embark on an investment strategy the important thing is that it must stand up through the cycle – which means that over the long run you will be better off, no matter where the exchange rate goes. (moneyweb)