Brexit implications on personal finances – Part 3

Two weeks ago I mentioned six alternatives for managing Brexit fallout risk.  There may well be more possibilities.

Today I am going to write about the first two – doing nothing, and converting British Pounds into foreign currency either as cash or in a foreign currency bank account.

We will use GBP and US dollars as an example – but this could equally apply to any other currency.  The percentage costs for other currency pairs are going to be higher than the ones mentioned in this examples – since GBPUSD is one of the most competitive rates (along with EURUSD, USDJPY and such likes).  If dealing with CAD, or NZD or Mexican pesos, then the percentage costs will rise further.  Here we go…..

Option 1: Doing nothing

This is always an option, albeit a very passive one.  You will simply have 100% exposure to moves in the currency markets.

Option 2: Converting pounds into foreign cash

In discussing ‘cash’, it is not necessarily banknotes and coins.  It could also be money sitting in your bank account i.e. a bank balance.

Converting physical cash is generally a bit of a headache, depending on the amount in question.  If dealing with a few thousand pounds, then it should be fairly simple to withdraw British currency from your bank and then take it to a company such as bestforeignexchange (BFE) or to a  FX broker on Brick Lane or Oxford Street.  The first mentioned company shows a great comparison table of exchange rates

How much does it cost? The important factor here is not the commission or other transaction charges.  The pivotal point is the rate offered by the business.  As you can see any of these businesses will likely give you a rate distinctly different from the “real” market rate.  The real market rate is the rate that I actually buy and sell when completing the FX trades that I have blogged about.  For example: If the GBPUSD rate is 1.318 in the real market, then I can buy the rate at 1.3181 and sell the rate at 1.3180 and pay commission of 0.00005.

Assume a conversion of £10,000 into US dollars.  According to the linked table above, the High Street broker will give $12,780 (using rate of 1.2780).  The real value of the pounds was actually $13,180 – so you have lost $400.   Thus the notion of “charging you zero commission” that is often advertised is fairly useless.  [Incidentally, next time you fly out one of London’s airport, check the buy & sell offers from the foreign exchange companies located in the arrival and departure lounges – you will be truly shocked!!]

If you were to instantly convert your money back into pounds, then you would likely incur another loss of $400.  Thgeneris demonstrates the notion of the “bid-ask” spread.  The broker has a bid of $1.278, and an offer of $1.358.  The bid-ask spread in this scenario is 800 pips – the difference between 1.2780 and 1.3580. In contrast BFE will give you $1.3055 for every pound (130 pips from the real market rate).  Thus their spread is 130 times 2 = 260 pips, significantly better than 800 pips.  As a percentage, the 260 pip spread is 1.9%   (0.026/1.3180).  An 800 pip spread is a cost of 6.1%.  To reiterate – the bid-ask spread measures your “round trip cost” – converting GBP into USD and then back into GBP some time later.

Why does this matter?  If you decide to convert the cash, and the real market rate were to stay constant, then you would lose 1.9% (£190) or 6.1% (£610) respectively on your £10,000 of savings, once you converted it back.

Safekeeping issues – you can open a US dollar account with your normal bank (say Lloyds or Santander etc) – however generally depositing foreign cash into these accounts is difficult/impossible/expensive.  My bank told me that I could only wire money into the account or deposit foreign currency cheques, but I could not deposit US banknotes and coins into it.

Thus, you then have the issue of how to keep the foreign currency safe.

Account Transfer & Bank Wires

If dealing in larger amounts, it is probably necessary to disregard the banknotes option altogether. Opening a foreign currency account now becomes necessary.  You then conduct a currency conversion whereby you ask your bank to wire the money from your GBP account to your newly created USD account.  In doing so, they will automatically convert the money for you.  In doing so, their bid-ask spread, if you don’t negotiate it with them, will likely be 400-600 pips.  Again, quite a hefty charge.

FX Brokers – Realising that banks are making a killing from these transactions (and they really are making a killing from it!!), many companies have popped up in recent years offering you much more competitive rates.  Examples are FTT Global (whom i have used it a 20-30 times already), Transferwise and many others.  Not only do they offer more competitive rates, they also provide a much easier process – allowing everything to be done via telephone and online instructions.  Very useful if you want to send money to family and friends in other countries, or for business transactions.  They offer individual and business accounts.

The bid-ask spread on GBPUSD from these companies will be 250 pips or less if you are doing £100k.  Still a whack, but significantly then the spreads listed earlier.   Don’t be afraid to negotiate!

Thus if you have £100,000 to convert, do the following: Open a USD account with your bank, open an account with an FX broker – then send money to the FX broker from your GBP account, and instruct the FX broker to send the converted USD amount to your USD account.  No safekeeping issues.

Foreign currency account fees – Oh, and your bank will charge a maintenance fee for keeping the account open – Lloyds quote me a monthly fee of £8.  On my company’s USD account, I have been paying £60/year for my company’s USD for the last few years.

Once you want to convert the money back into pounds, you can follow a similar process using the FX broker. You can also wire the money to a USD account anywhere  else in the world, or to pay USD denominated items.  Note you would unlikely be able to obtain US dollar notes from your UK bank.

Geez, there is a lot of information to convey and explain.  Am hoping that this is helpful to readers?  Let me know if you would like me to elaborate on some of the aspects.

questions

 

 

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One Response to Brexit implications on personal finances – Part 3

  1. Pingback: Part 4 (the final part!) – Managing Brexit risks | Trick or Trade

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