Expats frequently need to transfer money to and from the US for regular expenses or significant purchases like real estate. However, these international transfers expose them to foreign exchange risk due to currency value fluctuations. Furthermore, investments held in different currencies values can rise and fall relative to each other. To address the challenge of currency risk, expats can employ strategies that minimize losses during money transfers and plan to invest in ways that mitigate these risks. In this article, we delve deeper into these currency risk mitigation strategies, providing you with insights to help you navigate the risks of losses due to currency movements as a US expat.
In this article, we’ll cover:
- The nature of currency risk
- Mitigating currency risk
- Currency matching
- Diversified multi-currency portfolio
- Exploring hedging instruments
- Currency brokers
- An example of currency risk management when saving
- Final Thoughts
The nature of currency risk
Currency risk, also sometimes referred to as foreign exchange (FX) rate risk, is the risk of losing out due to unfavorable exchange rates when either transferring money internationally or due to holding assets in multiple currencies. The larger the sum of money you’re transferring or the larger the investments in multiple currencies, the greater the risk. For instance, if you’re transferring funds from the US to purchase property abroad (or vice versa), even a slight fluctuation in exchange rates can significantly impact the cost of the transaction. Another example is if you hold your retirement savings in the US but retire abroad and the dollar weakens relative to the currency where you live, the value of your retirement pot would decrease relative to living costs where you live..
Mitigating currency risk
Currency matching
Currency matching is a strategy for reducing the risk of your investments decreasing in value due to currency movements. It involves matching your assets’ and liabilities’ currency. So, if you expect to live and incur expenses in a specific currency, you could consider investing in assets denominated in that currency. For instance, if you’re living in Europe temporarily but plan to return to the US, you would focus on USD-denominated assets but if you have moved from the USA to Europe permanently then you might consider holding Euro-denominated investments.
Diversified multi-currency portfolios
Building a diversified investment portfolio across different currencies can help mitigate risk. Thanks to the globalization of finance and the availability of investments such as Exchange Traded Funds (ETFs), expats can construct multi-currency portfolios through US brokerage firms. A small number of US brokerage firms also offer access to non-US investment exchanges where local currency investments may be purchased directly. These portfolios can offer exposure to various currencies while keeping costs manageable. Always seek advice from an expat financial planning expert though to ensure you minimize your US and local taxes when investing, too.
Exploring hedging instruments when making larger money transfers
- Future contracts: Future contracts are formal agreements between two parties aiming to buy or sell currency at a predetermined price on a specific date in the future. These contracts are traded on a futures market and come with standardized sizes and quantities.
- Forward contracts: Similar to future contracts, forward contracts establish a price and future date for a currency transaction. However, they differ from future contracts in that forward contracts are privately arranged, customizable, and settled upon the contract’s conclusion.
- Options: Options, considered financial derivatives, grant buyers the right to acquire an asset, such as foreign currency, at a predetermined price. With options though, buyers are not obligated to exercise the right, providing expats with an additional layer of flexibility.
- Tranche trading: A method for handling significant currency exchanges by breaking them into smaller, more manageable parts. This approach helps individuals navigate currency market fluctuations effectively, reducing exposure to volatility and optimizing transaction outcomes.
- Swaps: Currency swaps represent another derivative instrument that enables you to secure a pre-agreed currency value in advance by negotiating an exchange rate with someone planning to make a reciprocal transfer. Should you require guidance, currency specialists are available to offer their expertise, so don’t hesitate to seek their advice when needed.
Currency brokers
In general, it’s always beneficial to seek advice from a specialist international currency broker when transferring larger sums internationally, as they will help you minimize the currency risk as well as the costs. For smaller or regular sums, firms such as Wise or Moneycorps are also useful, efficient options for expats.
Using a currency broker, you should save 2-4% in terms of the exchange rate compared to sending via a bank, when factoring in the typically lower transfer fees associated with brokers alongside better exchange rates. While these savings may appear modest for smaller transactions, they accrue significantly over time and especially for larger transactions.
An example of currency risk management when saving
Consider an American expat in Europe who intends to save for their child’s education in the UK. Initially, they might think of investing in a USD-denominated CD. However, if the British Pound appreciates significantly against the USD during the investment period, the purchasing power of the investment may remain unchanged or decline. To mitigate this risk, it would make sense to invest in a GBP-denominated CD at the outset.
Additionally, it’s essential to realize that the currency denomination of your brokerage account or investments isn’t relevant: what matters is the currency denomination of the underlying investments.
Final Thoughts
Understanding and managing currency risk is an importing aspect of financial planning for Americans living abroad. By aligning your assets and liabilities, diversifying your investments across currencies, and utilizing hedging instruments when necessary, you can safeguard your financial future while enjoying your expat experience.
If you have any questions about financial planning as an American living abroad, get in touch.
This article is for informational purposes only; it is not intended to offer advice or guidance on legal, tax, or investment matters. Such advice can be given only with full understanding of a person’s specific situation.
