Managing Currency Risks When Moving or Living Overseas
If you are among the millions of Americans working overseas or deciding to retire abroad, you must incorporate currency considerations in your investment portfolio and financial plans. Few realize it until it’s too late. Yet, some easy-to-implement solutions can help.
What is Currency Risk?
The currency risk, aka foreign exchange or exchange-rate risk, refers to losses a financial transaction may incur due to currency fluctuations. It comes from a mismatch between currencies for future expenses or liabilities on the one hand and current income or assets on the other. Here are two examples:
- You worked for a U.S. multinational company in France for the last ten years and probably will continue to do so in the foreseeable future. You have a daughter who has expressed interest in attending a 4-year college back in the U.S. You and your spouse have diligently been adding to a savings account with a French bank every year to cover her tuition. However, three months before your first college invoice, the U.S. dollar appreciated 20% against the Euro (an extreme move, but it did happen during the summer of 2008). Your daughter’s education cost suddenly increased dramatically, and you wonder if you can make up for the difference.
- Five years ago, you and your spouse decided to retire in Portugal to take advantage of a lower cost of living. You planned on selling your house in California and buying a much cheaper home in Portugal upon retiring, with the difference going toward covering a portion of your future living expenses. However, during the last five years, the Euro has significantly appreciated against the U.S. dollar. You are now concerned that you will outlive your savings.
Ways to Reduce Currency Risks
In both our examples, these unfortunate Americans could have reduced or avoided their predicament by focusing on matching the currency denomination of their assets (savings, investments, etc.) with that of their future liability (tuition, home purchase, etc.).
In our first example, opening a college savings account in U.S. dollars would have been more appropriate to match the tuition currency. This would have insulated future payments from any adverse movement in the exchange rate. In our second example, finding a solution was a little more complex. Depending on this couple’s situation, one possibility could have been to invest their future home down payment in Euro-denominated investments. Another option could have been to sell their California home five years ago and rent instead, then reinvest the sale proceeds in Euro-denominated investments until their move to Portugal.
The bottom line is that Americans living or planning to move overseas must take a hard look at their investment portfolio, real estate, and current sources of income. Some should remain heavily oriented towards U.S. stocks and bonds if they only temporarily live overseas. For others, who expect a more permanent move abroad, their investments should be anchored more around foreign securities.
In both scenarios, though, a portfolio properly diversified across the world will still include significant underlying investments in U.S. dollars and Euros due to the size of these economies and capital markets (see “One Last Point” below). It is also common for many American expats not to have a definitive idea of where they will end up. In this case, diversification is critical. However, once a decision is made (e.g., studying in the U.S.), it is vital to fund that future liability with the relevant currency-denominated asset.
How Does Bristlecone Help?
The globalization of finance and the development of efficient and inexpensive investment vehicles in America, such as Exchange Traded Funds (ETFs), allow us to construct a diversified, multi-currency portfolio right in our clients’ IRAs or brokerage accounts at any of the firms that we use for custody.
Not only is this usually less costly and complex than investment options available overseas, but for many reasons--some of them having to do with U.S. tax laws--it is recommended that Americans living overseas invest through U.S.-based financial institutions. Doing so is more likely to produce better after-tax investment results for U.S. citizens (and green card holders).
One Last Point
Investors often confuse the currency denomination of their brokerage firm’s monthly statement or their holdings, such as mutual funds or ETFs, with their investments' actual foreign exchange exposure. The currency used on the statement or for the funds is generally irrelevant. It is merely a reporting convention for the exchange where the security is traded or for the brokerage firm limited to reporting in one currency. The investor’s actual currency exposure and risk are determined by the underlying investments (e.g., shares in companies such as Nestlé or Louis Vuitton) in the account and within the funds held in the account.
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