(Newswire.net — November 27, 2015) — Interest rates in the US have seen sustained historic lows, just as they have in Europe.
Should an interest rate rise come soon in the US then it looks highly likely that there will be a divergence between American and European interest rate policy.
The cause of this divergence can generally be described in just a few words. Those words are: American economic recovery; and European economic weakness. While the economic news from America has strengthened month by month, the situation in many of the largest economies in Europe continues to stutter gently along.
Considering that the EU was demanding structural reforms after the financial crisis of 2008, there seems to be precious little that has actually been done in some countries. Some larger countries, such as France and Italy, that were not bailed out, but found themselves in uncomfortable positions for some time, seem to have skillfully avoided making any painful changes. They will have learned lessons from other countries that harsh austerity and reform causes governments to collapse. Repeatedly.
What does all this mean for private investors?
A change in interest rate policy is very likely to trigger movements in the currency markets. While some of these are quite predictable, others might surprise us. What it ultimately means is that depending upon where you, your investments and your local currency are, total investment values might be even more volatile than usual.
It is also worth noting that trends can be very profitable: the strength being shown in America and the weakness in the eurozone are unlikely to change overnight, so once a trend is established there is a very real chance of it maintaining momentum. When you are on the right side of momentum, it is a beautiful thing, but being on the wrong side can be an increasingly painful and costly experience.
For newcomers still new to the world of investment, understanding and judging the level of risk involved in a given holding can be quite tricky to do. When it comes to risks, currency risk is something that many investors often overlook, but it can have a profound impact on overall investment returns – both good and bad. Understanding currency risk is one of those stock market tips that can make or break a private investor.
Obviously, some holdings are very illiquid and may be impossible to rebalance. For example, real estate investments would be a large part of a family’s balance sheet, but is almost impossible to hedge effectively. In contrast, stock, bond and fund holdings can be tweaked to improve their weighting or adjust their impact on the risk profile of a portfolio.
While we traditionally use a new year as a time for a new look or start in our finances, this December looks to be a good time to reassess.