This article was published on 14 June 2005. Some information may be out of date.

Investing offhore not as risky as it seems

It’s an oft-quoted excuse for not investing offshore: If you do, you take on foreign exchange risk. But is it really risky?

In a recent column, I pointed out that if foot and mouth disease had been confirmed in New Zealand, those with some of their savings in overseas assets, such as shares, would have been considerably better off than most people, whose houses, jobs and savings are all in the local economy.

That prompted a letter from a reader, who suggested that I “may like to cover the exchange risk in a future article.”

“If the New Zealand dollar increases or the US dollar continues to decline, the value of the offshore investment will reduce, as some of us have found over recent years,” he wrote.

“On the other hand, if there was an actual foot and mouth disease outbreak, I guess the New Zealand dollar would crash and the offshore investments would increase in value, in New Zealand dollar terms — which just goes to prove the old proverb ‘It’s an ill wind…’ etc.” Quite.

A paper by the Reserve Bank and Treasury says the Kiwi dollar might drop about 20 per cent in the first quarter following a foot and mouth outbreak, and stay “below the baseline for around two and a half years.”

That’s way bigger than the usual fluctuations, of less than 8 per cent in a year. And it would certainly boost the portfolios of those with offshore investments.

But what about the harm to their portfolios if, instead, the Kiwi dollar continues to rise? I have two responses:

  • If you want to avoid foreign exchange risk, you can invest in a hedged international share fund.

    The fund managers buy financial instruments that cancel out the effects of foreign exchange changes. You won’t gain if our dollar falls, and you won’t lose if it rises.

    Alternatively, you can go into a fund with 50 per cent hedging, which halves the effects of exchange changes.

  • Over all, you may actually reduce rather than boost your risk by being exposed to foreign exchange movements — especially if you are saving for retirement.

It all hangs on how much of your savings you expect to spend on overseas travel or on imported items — such as electronic goods, cars, boats, many clothes, books, music and so on.

For many in retirement who have a mortgage-free home, travel and imports can be quite a high proportion of total spending.

Let’s say, for you, that it’s 30 per cent. It’s best, then, to have 30 per cent of your savings offshore.

When the Kiwi dollar falls, which makes imports and overseas travel more expensive, the value of your offshore savings will rise to compensate.

True, the reverse will sometimes happen. When the Kiwi rises, your offshore savings will lose value. But you won’t mind too much, because at the same time imports and overseas travel will be cheaper.

Confused? All that really matters is that, if you plan to spend a chunk of your savings on imports or overseas travel, it’s best to put a corresponding chunk of those savings offshore.

Footnote: Changes proposed in the recent Budget will, if they go ahead, tax offshore shares more heavily than New Zealand shares.

The government will soon release a discussion paper on the proposed changes. I hope the discussion leads to the removal of these tax differences.

New Zealanders are better off if they diversify their investments offshore. And if individuals are better off, surely the whole country is.

If the next foot and mouth scare is real, any government that has discouraged offshore investment is going to look pretty silly.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.