There are only three certainties in life. Death, taxes and the that Ghanaian Cedi and the Nigerian Naira will depreciate every year. Well, perhaps that is an exaggeration. Nobody can time the currency markets or predict the future with 100 percent certainty.
Yet the overall trend is clear. One dollar bought 0.91 Cedis in 2007. It now buys 5.85. One Dollar was worth 138 Nigerian Naira in 2003, and now buys a whopping 381 Naira. These currencies are just two examples I could have used from around the world.
Currencies all over the emerging world, from Latin America to Africa, have depreciated in a big way in recent years and, in some cases, decades. This has often meant that a 15 percent yearly local currency return, or even 25 percent has been lower than a USD return of 8 percent or more.
How can investors deal with this risk safely?
The most obvious way is by, first, having a diversified portfolio which is invested in global assets, such as MSCI World or the S&P500. By purchasing such assets, you gain access to currency and global asset diversification.
The S&P500 might be an American index, but the companies listed on it sell globally. Apple and Amazon, to use just two examples, make more money outside the United States than they do locally. This results in currency diversification considering most of the sales are in non-USD currencies around the world.
Second, holding your stock market assets long-term is key for risk mitigation. Markets do go up long-term. The Dow Jones in the US was trading at 66 in 1900, 2,000 in 1989 and is now sitting at about 31,000. The S&P500 has produced 11 percent since 1950, if dividends had been reinvested, and 7.5 percent after inflation. The tech-focused Nasdaq has done even better.
Yet everybody knows markets can be volatile. They can crash and fall. This isn’t a problem for the long-term investor who waits it out. The S&P500 has been up on 74 percent of years, and down 26 percent of the time. Yet over a ten-year period, investors have historically been up 90 percent of the time. It has never happened before that somebody has been down over a 25-year period.
Also, of utmost importance is dividend reinvestment. Global stock markets produce both the possibility for capital appreciation, but also give investors back a dividend – typically paid out quarterly or yearly.
The media, both social and traditional, usually only reports on the capital values of stock markets, despite the importance of dividends. Dividends are important because even markets which have underperformed the US stock markets in recent times, like the UK FTSE 100 and Japanese Nikkei, have performed better than expected if we calculate dividends.
The FTSE100 has only gone up 10 percent in 20 years, which is below inflation, and is currently about 10 percent below its 2018 record high. This wouldn’t have stopped an investor who invested during 1999-2000 from receiving 5-6 percent per year, if he/she would have simply reinvested dividends from the index.
An even more striking example is the Japanese Nikkei 225. It is the only major stock market index which is down over a 30-year period in terms of capital values, but it would have given an investor a positive return if dividends were reinvested.
Finally, carefully consider whether you have the emotional self-control to be a do-it-yourself (DIY) investor. Vanguard, the world’s second largest asset manager after BlackRock, has a great online series called “advisor’s alpha”, which looks at whether advisors can benefit the average investor.
The research concluded that DIY investors who invest in Vanguard funds and ETFs get lower net returns than those who invest through advisors. The main reason for this is emotions. Net inflows into Vanguard funds were high during 1999, after an eighteen-year bull market. Almost everybody had fear of missing out (FOMO) during this period. Unsurprisingly FOMO didn’t last forever – net outflows increased during the 2008 and 2020 crashes – despite the incredible buying opportunity such crashes presented.
Fidelity, another large asset manager, recently announced that 35 percent of their DIY investors sold out between late February and May 2020. Markets recovered. Those accounts did not. I see the same trends every time there is a market dip or crash, US election or another unexpected event like Brexit – people panic sell or at least stop investing fresh money.
This even happens to people who “pledge” that they won’t take such actions and know that trying to find the perfect time to enter the stock market isn’t as sensible as investing today.
Speaking about emotions, avoid the opposite end of the spectrum to fear – greed. Fear and greed have resulted in countless investors losing money over the decades. Numerous investors put a majority of their portfolio into China and emerging markets after a great run in the 1990s and early 2000s.
Since then, these markets have performed badly compared to the US and the majority of other developed markets. That won’t continue forever. Emerging markets will outperform during some periods and underperform at various intervals. Just don’t assume that African stock markets will outperform in the next few decades just because the economic outlook is quite rosy.
The relatively poor performance of Chinese stocks should be a warning sign. It illustrates the importance of having a well-diversified portfolio which doesn’t just focus on the African growth story.