Monday, April 18, 2011

Investing with US Dollars in the Philippines (Part 1)


Dear Investor Juan,

I'm a 30 something software developer who has been blessed to work from home for over a year now. I'm currently earning around 2-3K dollars a month and with the dollar-peso exchange rate being not so good nowadays, what advice can you give to make our money work for us instead of the other way around?

I look forward to your posts in your awesome blog!


Dear WorkFromHomePinoy

The way I see it, investment decisions (how much to invest in which assets, when) of individuals (like yourself) and households (like OFW families in the Philippines) who receive wages or income denominated in US dollars or some other foreign currency, depend heavily on two things: your expectations of future exchange rates and the financial characteristics (like risk and expected return) of available foreign-denominated investments in the Philippines. Let us then use this simple framework to evaluate the alternatives available to you and come up with guidelines that can help you arrive at a more informed decision.

Exchange rate expectations

Since you earn in US dollars, you should first come up with a judgment or opinion about how exchange rates will behave in the foreseeable future before you come up with an investment strategy. In other words, you need to decide whether you believe the USD to PHP exchange rate will go up or go down, or more or less stay the same, within your investment horizon.

Average Monthly USD to PHP Exchange Rates

The exchange rate between the currencies of two countries is primarily determined by how these countries compare in terms of several factors, which include, among others: inflation, interest rates, trade surplus or deficit, debt exposure, political stability, and economic performance. Generally, a strong local currency (lower exchange rate vs. a foreign currency) is associated with a strong economy, just as when the peso appreciated to its highest level in seven years at 41.74 pesos to 1 USD in 2007, the same year the highest recorded GDP growth rate of 7% was posted in the period. Therefore, to have a rough estimate of how the peso will perform against the US dollar, say, in the next 5 years, gauging how well the economy will perform under the present administration versus the previous (or at least how the public and the international community will perceive this government will do), and how well the country's performance in the next 5 years will compare against the performance of the US in the same period, would be a good place to start. If you believe that the country will do just as well as in the past year, or even better, and that the US will continue to have problems, then the peso should strengthen even further (and make the USD cheaper), or at least stay at around the same level; of course, if you have a contrary opinion about the government and the economy's future performance, then it would make more sense to believe that the peso will eventually devalue.

How should these expectations affect your investment decision? If you believe the peso will remain at its current level or appreciate within the next five years, then  your best move would be to convert your investment capital to peso now and just invest in peso-denominated securities, some of which we have already discussed in previous posts like this one; if, on the other hand, you think the US dollar will eventually bounce back and that the peso will substantially weaken, then you should keep your investable funds in dollars and invest in dollar-denominated assets now, and just liquidate your investments and convert to peso when the exchange rate reaches a level that's to your liking.

In Part 2 we'll look at the commonly available US dollar-denominated investments in the Philippines and how these compare to their peso counterparts that we're more familiar with.
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