The devaluation of our currency (COP) has been a major challenge in Colombia for years, not only for consumers, also for investors and entrepreneurs. One of the questions that is always on the table is:
- For Colombians: how different would be my return if I had invested in USD rather than COP ?
- For Americans: how different would have to be my return to invest in COL rather than COP ?
What we are about to see is a super short and easy way to answer both questions. This is not an advanced financial study rather a simple calculation that many people can do and or verify.
Let’s assume an investment of $500.000 COP in Jan 1990. The investor took the money in COP and changed it to USD at an exchange rate of $439,92 COP/USD. That made an initial amount of $1.137 USD.
Now let’s assume the investor allocated the money to follow the most popular index in financial markets: S&P 500 (the market capitalization weighted index of 500 of the largest companies listed on stock exchanges in the US). In Jan 1990 a unit of S&P 500 was at $359.69 USD, which meant that the initial investment was for 3.2 units of the index.
After almost 35 years, those $500.000 COP have become $18.353 USD. That is an annual return of 8.3%. This is the answer for Colombians.
The investor changes those USD to COP in Oct 2024, at an exchange rate of $4.316,73 COP/USD, getting $79.224.298 COP. From the initial investment in COP ($500.000), this equals an annual return of 15.6%. This is the answer for Americans.
Let’s pause here for a second, and think:
- In Colombia what would be that asset or industry from you can get that annual return for such a long period of time?
- Think as an entrepreneur, but please also think as a fund pension manager (and yes, if you’re a Colombia reading this, think about your pension).
Let’s resume:
Then the answer to our main question is: 1.88 times is the minimum acceptable difference in expected returns that we should consider to invest in COP over USD.
- Quick note 1: this number is the result of using current market conditions.
- Quick note 2: if we use an exchange rate of $4.968,94 COP/USD (highest registered) then the difference would be 1.94 times.
At first glance it might seem irresponsible and arbitrary to use only this period of time and entirely based any conclusion from there. To have a view of the numbers in different time frames, the same calculation is run from 1995, 2000, 2005 and so forth.
There is a systematic outcome where expected returns are higher in COP than USD. We can also say that an acceptable ratio for the expected in returns in COP tends to be the double compared to USD. COP would give higher returns but in a weak currency.
Additionally, the effect of inflation is another thing to consider. That could be addressed in a subsequent blog post. However, inflation in COP is usually higher than inflation in USD.
This blog post was inspired by the article El dólar nunca es caro. Credits to Nicolas Fernández.