It's the holiday season, so it's a certainty that someone, somewhere, is being fleeced on their foreign currency right now. But if you've ever thrown a few euros into the back of a drawer only to find they're worth more in sterling the next time you fish them out, it's tempting to think of taking things a stage further and using currency fluctuations to make money. There are plenty of opportunities to invest in and potentially gain from currency fluctuations. But for the unwary, doing so is likely to be a recipe for losing money.
Why? Because there are extreme risks involved in currency trading. For instance, with the so-called debt contagion currently hitting the eurozone, there are fears of a euro crash. While that would be very bad news for the economies concerned, those who move their cash cleverly could avoid being hit by a potential devaluing of the currency. But currency speculation is a huge gamble which, if you pick the wrong choice, could see you badly out of pocket. On the other hand, there are strategies you can follow for your holiday money, or if you plan to buy a home abroad.
For instance, if you know you are going to need a fistful of foreign money in a few months' time, it could pay you to buy it ahead of time if conditions are right. So, for instance, if you could buy euros at 1.50 to the pound, you'd get 1,500 euros for £1,000. If the euro then strengthened to parity with the pound – so that you'd only get a euro for a pound – your 1,500 euros would actually be worth £1,500. So you'd have gained a profit of 50 per cent just by buying your currency early.
The problem, of course, is that no one can predict the future, and the chances of lucking into such a beneficial deal which goes in your favour are extremely slim. Last week, for instance, when Italy and Spain were infected with debt worries, the euro lost four per cent of its value against the dollar and was the worst-performing currency. The Italy and Spain debt news led to foreign exchange traders fleeing from the single currency to put their cash in safer homes. But few were tempted to switch into sterling.
"The pound has been helped by the fact that it is not the euro, but apart from that it has little else going for it," said Michael Derks, chief strategist at the foreign exchange dealership FX Pro. In other words, if you were holding only sterling, you wouldn't have noticed much of an improvement against the euro.
In fact, as far as the currency market is concerned, there are currently three big safe-haven currencies: the Japanese yen, the Swiss franc and the US dollar. With specialist dealers you can trade almost any currency against another, so, depending on your view of global markets and currency movements, you could think about switching your cash from sterling to the yen or the US dollar to reduce the dangers of losing out through currency fluctuations.
Alternatively, you could take a contrary approach and switch cash into the euro to take advantage of the unlikely scenario of a sudden recovery in the currency. How unlikely is that? Not all the experts are calling a crash, and the fact that the euro remains relatively strong suggests that the foreign exchange market isn't really that worried about it.
Willem Sels, HSBC Private Bank's UK head of investment strategy, thinks the single currency has a positive future. "In our view, the euro will survive, and longer-term the European economy will emerge from the current crises in much better shape as debt loads are reduced and structural economic reforms are made that should enable the economy to return to decent levels of growth."
Who's right? Only time will tell, which is part of the problem of trying to beat the currency market. There really are no definites, and the market can swing wildly on sentiment, or on what traders predict or worry might happen. If you're not a professional trader, therefore, it's almost impossible to keep ahead or even up with the game, which means it's very easy to get your fingers burnt.
However, taking a long-term view can be a good option if you're planning a major purchase abroad – such as a holiday home. If you can find a currency deal at a rate that you're happy with, it could well be worth doing the deal. For instance, with the sterling-euro rate hovering around the 1.14 mark recently, it could be tempting to buy if the price reached €1.20 to the pound.
There would remain the risk that the euro would weaken further – to maybe 1.30 by the time you need the currency – but if you've got the currency you need at a rate that pleased you, then that can be enough to relax and ignore subsequent ups and downs. In short, acting when the currency price reaches a level which improves the affordability of your overseas asset can make good sense.
Cash in on currency
The simplest way to play the currency game is to buy hard currency through a specialist broker such as HiFX or Moneycorp for larger amounts – at least £5,000 – and keep it in a higher interest account that accepts that currency. This is a popular choice among overseas property owners or expats as the company is dealing in large sums and can offer extremely competitive rates – often within 1 per cent of the rate banks deal with each other at – known as the interbank rate. As with any type of investment, though, there are lower and higher risk currencies among the 150 or so on offer. If you're going it alone like this you'll need to be pretty clued up on the macroeconomic factors affecting both the currency you're investing in and the pound, particularly as foreign exchange brokers don't have to be regulated by the FSA (although the reputable ones are).
If you fancy taking a punt on foreign exchange, the easiest way to access currency markets is through a fund. There is quite a range to choose from and buying into one will mean benefiting from the research and experience of fund managers, rather than having to do all the work yourself. "It really depends on whether you need a specific currency or exposure to movements in exchange rates, how much direct exposure to a currency you want and for how long," says Paul Dimambro, head of currency service at the financial adviser Hargreaves Lansdown. Several fund managers offer private investors currency funds, such as Investec, Fidelity, and Schroders, with recent new fund launches including riskier, but potentially more rewarding, emerging market currencies than the traditional euro, dollar, pound and yen.
"In general, the Swiss franc and Japanese yen tend to do better in uncertain times and high-yielding currencies such as the Australian dollar push on when commodities are up," Dimambro explains. "For short term, investing in a derivative product could be an option, but longer term the charges add up and it would be rash to try to work to short-term forecasts as there are just too many factors which could affect movements in one way or another." He suggests an ETF for medium to longer-term investing – an exchange traded fund with low annual management charges that tracks an entire currency via an index, such as the S&P 500. However ETFs bring with them their own risks, and you really should take expert investment advice and understand the risks to your cash before going anywhere near them.
Place your bets
Then there's the rock'n'roll option: spread betting, where you don't actually own any currency, but place a bet on it moving up or down. The pay-off depends on how accurate you are. It is a popular choice with UK investors as there's no capital gains tax to pay on winnings, nor is there any stamp duty to pay as you don't actually own the currency.
"Spread betting allows you to trade on market movements to take advantage of both rising and falling prices, 24 hours a day," says Mike McCudden, head of derivatives at Interactive Investor, which offers spread betting accounts.
"For example, you might have just bought some euros for an upcoming holiday, and you are worried because you think the value of the money you have bought is going to go down before you go. With a Forex account you can place a bet – a "short trade" – on the euro going down in value against the pound. If it does, you have protected your exposure to the fluctuations in the currency markets and made some money along the way.
"As well as having the potential to profit from falling as well as rising prices, you also pay no commission on trading currencies in this way."
But this is gambling territory. Spread betting is leveraged, which means your initial deposit or bet is small compared with the portion of the currency market you tap into. That means you could become exposed to losses in just a few minutes that are far larger than the original amount you put down. To cash in on this one you'll need to know a lot about the market, monitor your account very closely and use a stop-loss order to automatically close the spread if it starts to fall off a cliff.
Cash or card for holiday currency?
Anyone who turns up at the airport before thinking about their holiday spending is likely to get stung by commission, fees, painful exchange rates, or all three, at the departures lounge Bureau de Change. But pre-ordering your cash for collection can help to secure a better rate, and is often available until around four hours before you need the money. If you can make it to the high street before you check in, Marks & Spencer, the Post Office and Thomas Cook usually offer the best exchange rates, although online providers such as Travelex may beat them to it.
Watch out for seeming "best buy" rates that carry a transaction fee (anything from £3 to £8 or £9), check for delivery charges, and bear in mind that many currency companies won't be FSA-authorised.
Using credit or a Visa debit card to make your purchase should give you protection against your provider going bust. But if you charge cash to a credit card, either at home in sterling or overseas in the local currency, you'll pay up to 32 per cent in interest. But that doesn't mean relying on your usual debit or credit cards is the best solution either. Withdrawal fees can be 2.75 per cent per transaction. And that's before you take into account any fees levied by the ATM providers themselves, or the typical 3 per cent load cost to the exchange rates that many cards will charge you.
You'll often be better off with a credit card that won't add charges to the exchange rate such as Santander's Zero card, Halifax's Clarity card, the Post Office credit card or Saga's Platinum card for the over 50s. Just clear the debt as soon as you're back.
If asked whether you want to pay in the local currency or sterling, never pick sterling. This would mean the merchant doing the conversion themselves, often at a worse rate than even the banks inflict.
Prepaid currency cards, such as FairFX or CaxtonFX, offer protection comparable with a credit card, you just have to load them with cash first. Available in sterling, dollars and euros, the better ones are usually available free online with competitive exchange rates that vary daily, no delivery costs, monthly or transaction fees.