The Australian dollar has done its fair share of bouncing around during the last five to ten years, and its current trend is down. What does this mean for our investments? And what can it teach us about risk?
A recent research study comparing the strength of the Australian dollar with the prices Australian businesses charge for their goods and services revealed a fascinating pattern caused by the dollar’s turbulent travels over the last few years.
The Business Expectations Survey released by Dun & Bradstreet in January 2015 shows that our weakening currency appears to be contributing to higher input costs for Australian businesses. These higher costs are being reflected in the prices their customers are paying. So, as the Australian dollar drops against the US dollar, the majority of Australian firms expect to increase their prices.
This indicates potential future issues for firms that compete locally with operators from other territories. If Australian businesses have to lift their prices thanks to a falling dollar, it makes them less competitive in the market.
Dollar’s drop impacts business
Such pressure most strongly affects those businesses that rely on imported goods and services. In the Business Expectations Survey, a not-inconsiderable 21% of businesses surveyed said the Australian dollar’s value is the issue that will influence their operations the most, while 23% expected a positive impact from the dollar’s current levels and 25% expected a negative impact.
Pricing of goods and services is just one of many effects of the changing value of the Australian dollar in an increasingly global business environment. Another was identified in an article from The Australian newspaper in early January, titled ‘Australian dollar fall helps offset plunging commodity prices’. The tumbling Australian dollar was actually timely for the domestic economy, the article claimed, as it partly made up for the steep downturn in commodity prices (iron ore and crude oil prices, the article says, fell by 50% last year and coal fell by 28%) and helped to mitigate a potential spike in inflation.
Interestingly, the dollar’s rise and fall does not only flag specific issues that individual investors need to watch out for in terms of asset classes and industries, it also brings into focus questions about risk and return. After all, if a high dollar offers a certain industry, category or asset class less perceived risk, then surely a low dollar has the opposite effect.
How to analyse your risk profile
Even before considering the changes in risk patterns caused by a fluctuating dollar, investors should develop a detailed understanding of their own risk profile. This is not a set-and- forget exercise that only needs to be carried out once. Risk appetites and profiles constantly change throughout an individual’s different life stages.
So what questions need to be asked to come to an understanding of your own risk profile?
First of all, in finding a definitive answer investors should seek professional guidance from their financial adviser. But in order to develop a better understanding on your own, begin with questions around stage of life.
How many years do you have left in the market before retirement, or are you retired already? Do you have time to ride out the various ups and downs of the money markets? Are you investing for the short or long term?
Stage of life questions will also answer other risk-based queries around whether you have dependants, what types of expenses you see in your future (school fees, international travel etc), what income you make now and what your future earning potential may be, and whether you foresee any breaks in your career.
What is your investing experience?
The types and levels of investing you have done before, the investments you saw your parents become involved with, and the results of your past investments all influence your level of comfort with particular asset classes and levels of risk.
For instance, if you dove headlong into US shares a month before the GFC struck, then you may understandably be a little shy about dipping your toe into that pool again. And if your parents invested successfully in property then you are likely to have greater comfort with property as a result.
Today’s investment decisions should not be driven by yesterday’s results or experiences, but many of the world’s most respected financial experts, including Warren Buffett and Peter Lynch, argue that it pays to invest in what you know.
The trick in analysing your risk profile is to recognise which past experiences are pertinent and useful, and which are simply emotional memories that deserve to be erased or reset.
Are you comfortable on a roller coaster?
One of the great benefits of property ownership is that it is very difficult to check the value of a piece of real estate on a daily basis. If you could, you might find that you are regularly surprised and concerned.
How comfortable are you with the ups and downs that are so visible on the sharemarket, for instance? Are you willing to witness your investment shrinking in value over the short term in exchange for the potential to make greater gains over the long term? Or would you prefer to always see growth, albeit at a possibly slower rate?
There is no right or wrong when it comes to levels of risk aversion. There is no better or worse option. There is only your unique and personal take based on your current situation.
What are your goals?
Finally, what are your retirement goals, or your other reasons for investing? Are you hoping for a retirement that is currently beyond your means, or something more simple? How much will you need on an annual basis to make your desired lifestyle a reality?
And don’t forget shorter-term plans and expenses, whether it be a house, an overseas trip, a car or private school education for the children. They all have an effect on your choice of investment and the levels of risk that come with it.
What has it all got to do with the Australian dollar?
The rise or fall of the Australian dollar, or its rate of movement in general, puts various investment options into new categories in terms of risk and return (see ‘Winners and losers’ box below). It is important that these changes are recognised and understood by individual investors so they can ensure their portfolio is following its intended strategic path.
With such dramatic changes in the value of the dollar in recent months, and as you move into new life stages and therefore change risk profiles, consider discussing with your financial adviser whether you need to re-balance your portfolio.
Winners and losers
Most businesses can find both positives and negatives in the Australian dollar falling against foreign currencies. Banks, for instance, may benefit when they raise money from international markets but might also suffer thanks to a lower number of offshore investors. Manufacturers that export product can sell at a more competitive rate but may face higher costs for the resources required in the production process. Here is some food for thought:
Potential to benefit from a low Australian dollar
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US shares that are not hedged back to the Australian dollar
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Australian businesses with major US operations
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Exporters
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General retailers
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Tourism
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Agriculture export
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Resources
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Universities and other educational institutions that attract international student interest.
Potential to benefit from a high Australian dollar
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Importers
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Retailers specialising in imported goods
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Retailers specialising in white goods and electronics
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Businesses and assets that generate Australian domestic income only
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Australia real estate firms
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Property investors (low interest rates).