Personal Investing - pt. 2

A chart of a penny stock or of a national currency? The answer is in the blog.

Intro

A statement about investing I had heard several years ago recently resurfaced in my memory. I am going to review this statement from two angles in this blog:  first, by checking the data to see if the statement is true and second by applying standard investment concepts.

Main

The statement I mentioned before is: “I buy currencies. Currencies can´t drop to zero.” (He implicitly meant bonds and stocks do.)  Well, when companies go bankrupt their stock becomes worthless. Usually their bonds too.  Back then I found his statement right and yet not right. Today I do some digging on the topic. Currencies are very tightly connected to a country´s economic well-being. A currency loses purchasing power when that country goes bankrupt.

By the way the aspiring investor is in good company as I found out during my research. The man pictured below, is Walter Wriston (former chairman of Citicorp.), a US bank, today known as Citigroup and the following statement is attributed to him as I read in R street:  

“Countries don´t go bankrupt.”

Not only is the aspiring investor in good company I would say a majority of people would think the same way.  But, are they right? Let´s have a closer look.

Part 1: Research

I am presenting first some data on an individual level from cases I have heard in the news.

Argentine

I remember the country has been struggling in the last 20 years economically. According to an article from Wikipedia, since independence from Spain in 1816 the country has defaulted on its debt nine times. So on average every 20+ years, Argentine ceases to be able to repay its debt. That´s very often.

It´s stated further in the article large currency devaluations were one of the results of those defaults.  A third interesting fact is, Argentine was doing well economically and yet experienced a reversal in economical wealth in the 20^th century. Let´s have a look at the exchange rate of the Argentinian Peso. The graph you see below (sorry it´s german) asks how much does One Peso buy me Euros? Answer: At the start of the chart around 2005 one peso bought 25 € Cents. By 2025 one Argentinian peso buys 0 € Cents (Source: Google Finance).

Turkey

Another country I know from the news is Turkey. What´s the chart looking like for the Turkish Lira relative to Euro? I showed the chart at the start of the blog.

When you look at both charts - you realise they are very similar. So, a Turkish Lira bought 25 € Cents around 2016. Almost 10 years later a Turkish Lira buys 2 € Cents. A loss in purchasing power of 90%+. Had you received in 2018, 15 € Cents, expecting a reappreciation back to 25 € Cents, the opposite did happen, it got worse.  

I wanted to know the situation on an aggregate level, when you look at all the countries out there. How do countries fare as a safe haven for investment? According to Alex J.Pollock at R Street:

"In the last 100 years, from 1915 to 2015,

 there were 189 cases of sovereign defaults and restructurings.

 This involved 80 countries, many were multiple defaulters."

Turkey, Argentine this is so far away. If you think that can´t happen in Europe. I remind you of the Euro crisis which also was a debt crisis. The very existence of the currency was at risk too.

Part 2: Is buying currencies an investment plan?

An investment plan has to do with asset classes. An example for an asset class is stocks. I write about stocks in more detail in Personal Investing. As to currencies, they are not an asset class. Now, some consider them to be one according to an article from Pimco, a financial management firm:

"In recent years, investors discovered currencies

as a distinct asset class and potentially an

additional source of income."

That confirms by and large my knowledge. I see it as follows: when you go about investing it´s like with a sandwich. For a sandwich you need bread, butter, ham and cheese. You have the basics there. To add some flavour you add a tomato, lettuce and cucumber (as you see in the picture). A cucumber adds flavour but it does not replace the basics/fundamentals provided by the aforementioned ingredients. I ask you: Rather than having a sandwhich (bread, butter, cheese and ham), would you take solely slices of cucumber? I wouldn´t.

The same thinking applies to personal investing. The cucumber  is currencies. With solely a cucumber you stay hungry. Currencies are relevant for a personal investor but not in the role of an asset class as you learn in my course. There you learn about implementing the basics in your personal investments. Courses (List)

While I agree it´s good to start somewhere, I would not start with the cucumber: currencies may have some excitement but it´s not a concept for personal investing.

Summary

I started with a statement I had heard several years ago about how an aspiring private investor wanted to go about investing. I assessed in this blog the statement in two ways:  first I presented some research to verify “countries don´t go broke”. I showed on a country  level that it´s not correct. – I gave three examples. I also gave empirical evidence on an aggregate level citing an R street article. These “things” can happen everywhere. A blind belief in a country´s capability is probably counterproductive to a personal investor´s success.

In the second part I looked at currencies for their suitability as an asset class: buying a currency means taking some action. But, it´s not an action fitting an investment concept. I used to explain that by using a sandwhich as a figure of speech.  Private investors are not advised to start out with a non-essential – currencies.  For those who want to learn about sound investment concepts, check out my course on personal investment.

Sources:

 Economic history of Argentine (Wikipedia): https://en.wikipedia.org/wiki/Economic_history_of_Argentina

Countries don´t go bankrupt? The 20^th century proves otherwise (R Street): https://www.rstreet.org/commentary/countries-dont-go-bankrupt-the-20th-century-proves-otherwise/

Understanding currencies (Pimco),

https://www.pimco.com/eu/en/resources/education/understanding-currencies 

Charts:

 Turkish Lira / Euro: https://www.google.com/finance/quote/TRY-EUR?sa=X&ved=2ahUKEwjtpYmf3NWQAxWJhv0HHdt5FvEQmY0JegQIDBAu&window=MAX

Argentine Peso / Euro chart: https://www.google.com/finance/quote/ARS-EUR?sa=X&ved=2ahUKEwj-mObC2NWQAxUw9rsIHWwgBkQQmY0JegQIDBAu&window=MAX

Pictures:

Sandwhich: Shutterstock,

Walter Wriston: https://dl.tufts.edu/concern/images/g732dk21w

Frequently Asked Questions (FAQs):

1. Do countries represent a safe haven for personal investors? No, research shows that up to 2015, there were close to 200 defaults spread across 90 countries. When a country defaults a sharp drop in government bonds prices occurs and the nation´s currency devalues.

2. What do aspiring personal investors often do at the start? They start without a sound investment plan. They buy outlier asset classes based on false beliefs.

3. What is the result? Branching out without a sound investment plan decreases chances of success considerably and leaves more room for "luck". Also personal investors will more likely lose interest over time as their investing becomes sporadic.

4. Can defaults solely happen to countries far away from Europe? No. During the Euro crisis, several countries member to Euro currency were at high risk of default.

5. What does an informed personal investor do?

   A personal investor approaches countries and companies with a prudent eye and knows there is no certainty in the outcome. Also, applying an investment plan minimises the risks of unpleasant suprises in the future.