WITH current interest rates for the Singapore dollar at a low, many investors are flocking to financial institutions that offer attractive rates for foreign currency deposits. A foreign currency account is an account maintained in another currency. In Singapore, foreign currency accounts are denominated in currencies other than the Singapore dollar.
At the moment, banks are promoting foreign currency accounts aggressively. We see this on most bank websites as well in newspaper advertisements. It is no surprise that over the past few months, when advising clients on a stock portfolio, they usually asked me whether it would be better if they put their money in foreign currencies instead. Their argument is that they stand to benefit from the yield and the possibility of capital appreciation due to currency appreciation against the Singapore dollar. If the currency movement goes against them, then they will hold on to it.
Understandably, given the negative economic outlook in stock markets around the world, some people perceive foreign currencies as safe and high yielding investments, with some foreign currency accounts paying more than 8 per cent interest per annum. However, before you invest in a foreign currency deposit, consider the following.
Foreign talent: Given the negative economic outlook in stock markets around the world, some people perceive foreign currency investments as safe and high yielding
In the world of investment, there is no free lunch. Investing in foreign currencies has a risk-return trade-off, meaning higher potential returns are associated with higher risk. Foreign exchange markets can be volatile. Currency positions held in these markets may involve actual losses. Investors incur currency risk due to the possibility of large exchange rate movements against the Singapore dollar. From time to time, significant events can occur that disrupt the normal operations of financial markets. Examples are failure of a major financial institution, war or a major political event. Movements in exchange rates could result in financial loss to holders of foreign currencies.
Consider the exchange rate for the New Zealand dollar/Singapore dollar. If you invested in June 2005 and held until June 2006, your exchange rate would have changed from about 1.14 to 0.96. In Singapore dollars terms, you would have lost over 15 per cent due to the depreciation of the New Zealand dollar against the Singapore dollar. Even with an interest rate yield of 8 per cent, you still would have made a loss. Of course, the flip side is that you also stand to gain from the New Zealand dollar's appreciation if you invest at the right time. However, it is almost impossible to pick the bottom and exit at the top. All in all, the crux of the issue is that foreign currencies investing is risky and never a sure-win bet.
Then what about stocks? When you buy a stock, you are buying a piece of the issuing company. Admittedly, it's probably a small piece. But that share gives you the right to participate in the company's growth (or decline) and to vote on matters of some importance - directors, company auditors and some shifts in corporate policy. In some cases, you will also be entitled to dividends - payments of cash or stock to shareholders.
When it comes to risk, investors can take some comfort in the fact that over very long periods, stocks have appreciated faster than the rate of inflation and have outperformed other traditional types of investments. That's because companies tend to grow with the economy and prosper and because shares in them allow stockholders to participate in that prosperity. Of course, none of this is any guarantee that you'll make money on the stocks you buy, or that being invested in stocks during a market downturn won't be plenty painful.
Since there's an art and a science to picking stocks and most investors would rather leave it to a trained professional make those choices, unit trusts are a popular investment. Unit trusts are investment companies that pool the money of many people and invest it. The stocks or fund buys are determined by the fund's investment objectives - they are spelled out in the prospectus - and by the fund manager, who makes the investment decisions.
So when you buy a piece of a stock/equity fund, you're actually buying an interest in all of the different stocks held by that fund. That gives you the benefit of diversification, reducing the risk that your stock portfolio will be savaged by a single bad stock. Although they are affected by the same forces that affect the market as a whole, many funds are managed to take advantage of upward trends or to protect investors against bear markets.
For this reason, investors should rely on a well-diversified portfolio of equities and fixed income. Don't get me wrong, I am not totally against currency investment. In fact, a currency deposit can fit in as a minor part of the portfolio. However, investors should refrain from investing a large proportion of their portfolio in currencies because over the long term, movement of the foreign currency against the Singapore dollar may not be beneficial to the Singaporean investor.
Who should be suitable to open a foreign currency account? There are many good reasons for a person to put his money into a foreign currency account, such as hedging against exchange rate fluctuations for importers and exporters. If you open an account in the currency in which you make the bulk of your transactions, you can hedge against exchange rate changes by keeping money in the account until the currency rate is beneficial to you.
For those who plan to send your child to study in a foreign country such as Australia, saving your child's education fund in an Australian dollar denominated foreign currency account will help you to worry less about the possibility of the Australian dollar appreciation.
Individuals who are employed overseas or have regular income from abroad may also want to have a foreign currency account. For example, a non-resident working in Singapore may want to retain foreign currency salary received from his employer overseas.
Finally, read the standard terms and conditions very carefully. There are always some conditions attached to these investments. Personally, I'm not interested at this moment in a foreign currency account, when the stock market offers plenty of opportunities to buy quality stocks.
Foreign currency accounts are suitable for those who have specific purposes such as those mentioned above. However, if you have a lot of cash and you have established a proper asset allocation like equity and bond portfolio, foreign currency might be a good investment vehicle for you to diversify your portfolio.
Ben Fok is chief executive officer of Grandtag Financial Consultancy (Singapore) Pte Ltd.
