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The Cypriot Currency Calamity – a modern day horror story

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By Simon Danaher - September 09, 2015

…and how currency fluctuations impact your wealth

Cypriot CurrencyFirst, the terrifying story of what can happen when currency bites back…

The unsettling events began between 2003 and 2009, when as many as 15,000 British people bought properties in Cyprus. The buyers were a mix of buy-to-let investors and ordinary people looking to retire in the sun or enjoy a holiday home. Some of these buyers bought existing properties and some bought properties “off-plan” – that is, before they were built.

The horror story really begins though at the point when the buyers were advised to take out mortgages in Swiss francs. At the time, the Swiss franc was a relatively stable currency and the interest rates offered were comparatively low – little did these buyers know they had set in motion a terrible chain of events

When the financial crisis struck, tearing like the Grim Reaper’s scythe through European financial markets these buyers were caught desperately in the maelstrom.

The value of the Swiss franc increased, meaning the size of the buyer’s mortgages, and the repayments did too. While this was happening, the sickening shock to Europe’s financial system had a corrosive effect on property prices, with some of the properties in Cyprus losing up to 70% of their value, pushing many into negative equity.

To make matters even worse, some banks hiked interest rates, pilling yet more pain on these hapless buyers.

Many of these people face financial ruin and some have even found their British homes are now under threat. A court battle is ongoing.

A little knowledge can help

This story shows that it is right to be concerned about currency – and this is perhaps never more relevant than to those who are internationally mobile or living as an expatriate – but a little knowledge can really help.

Our advisers are frequently asked about currency. The biggest fears people have are around the erosion of capital, reduced investment returns and diminishing pension or other income withdrawals. These are all very rational fears, but often it is the not knowing which can cause the most unease.

Impact on investment funds

One of the most common questions asked of us is around the impact currency movements can have on investment funds. Despite seeming complex, the principles around this are actually quite simple.

For example, if you are using a dollar denominated fund which is buying company shares in a foreign country – let’s use Japan as an example – and the value of the dollar falls against the yen, the worth of the shares purchased will increase. Likewise, if the value of the dollar increases against the yen, the worth of the investments fall.

Let’s break this down slightly. Imagine you bought one share valued at ¥120 for $1. If the value of the dollar fell 10%, meaning to purchase that same ¥120 share would cost $1.10, the fund will have gained 10% on that share – a 10 cent gain in monetary terms.

While currency fluctuations can add to the performance of an investment fund, as in the example above, it can of course have the reverse effect. Because of this many fund managers use a process known as “hedging” to lessen its impact. Hedging is complex and involves the use of derivatives and other financial instruments – perhaps more on this in another blog…

Income fears

Another common, and very understandable, fear is that currency fluctuations will erode pension withdrawals or other sources of income.

An old advisory adage is to “save in the currency you are going to spend in”. Put simply, if you save in British pounds, for example, then move to Australia where the dollar has been strengthening, your wealth will be eroded in real terms – your spending power is less. We all experience this when we go on holiday and have to exchange money. It is unfortunately no different when it comes to pensions or anything else.

However, saving in the currency of a country you are planning to move to is not always possible, and of course, if you did and that currency depreciates, then you will lose out.

There are other steps you can take to lessen the impacts of currency movements and to help instil some certainty to your finances. We suggest using investment funds which are hedged, where possible, speaking to your adviser, if transferring large amounts of money between currencies, and also using offshore banking facilities, as these can help with the management of foreign currencies.

If you would like to ask us any questions you have about currency or anything else, click on the link below.