How will the plunging pound affect you?
It would be fair to say that so far, the fallout from Brexit has been relatively subdued. The economy hasn't suddenly collapsed as many economists seemed to be predicting before the vote and there's been no sudden exodus of international firms.
However, the one place where Brexit has clear made an impact is sterling. Indeed, since the UK voted to leave the EU on 23 June, the value of sterling against the US dollar has collapsed by more than 16% taking the pound to a 31-year low against the dollar. And last night, almost 6% was wiped off the value of the pound in a 'flash crash' event, which may not have any serious lasting effects but it shows how aggressively the market is positioned against the currency.
A severe impact
A weaker sterling will have a very serious impact on the UK economy. The UK is a net importer, and as the pound plummets, import prices are skyrocketing, which will inevitably cause an inflationary environment moving forward meaning higher prices for everyone.
Not only will UK consumers be forced to pay higher prices for goods here in the UK but holidaymakers will find the prices of holidays rising as pounds buy less overseas.
For investors however, the outlook is brighter. As the pound has fallen the FTSE 100 has rallied because the majority of the index's constituents are large multinationals that have overseas earnings. A weaker pound will boost overall profitability. For example, global pharmaceutical giant GlaxoSmithKline's management believes the company's earnings are set to receive a 19% currency boost if the pound remains depressed.
That said, not all companies will benefit. Firms that sell imported products in the UK will have to pay more in sterling terms to suppliers. EasyJet is the prime example. Shares in the low-cost carrier fell 6.3% yesterday and are down a further 4.1% today after the company warned on Thursday that foreign exchange rate movements are now expected to have a £90m adverse impact on earnings compared to the financial year to 30 September 2015.
Every company will feel the impact from sterling's movements differently so it's almost impossible to say how recent currency developments will affect investors as a whole. Some will profit, and some will lose out.
How should investors react?
Currency markets can be volatile and unpredictable. Basing your investment decisions on short-term currency movements is bound to end in tears.
So, long-term investors don't need to make any knee-jerk reactions to sterling's recent declines. Nonetheless, the recent action in the currency markets highlights how important it is for investors to diversify outside the UK and make use of today's interconnected trading world by diversifying into global assets and currencies. Investors with euro and dollar assets have profited significantly from sterling weakness. Moreover, as of yet, it's unclear how sterling weakness (and Brexit) will affect the UK economy. Therefore, exposure to other markets will likely pay off in the long run.
The worst mistake you could make
Not diversifying into other markets can be disastrous for your investment returns and a lack of diversification is often cited as being the main reason why most private investors underperform over the long term. Indeed, according to a study conducted by financial research firm DALBAR, the average investor realised an annual return of only 3.7% a year over the past three decades, underperforming the wider market by around 5.3% annually.
This underperformance can be traced back to several key mistakes that all investors make. To help you realise and understand the most common mis-steps, the Motley Fool has put together this new free report entitled The Worst Mistakes Investors Make.
Rupert Hargreaves owns shares of GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.