Financial challenges for Americans living and investing abroad include currency exchange rate risk, multi-jurisdiction tax and reporting rules, and cross-border diversification. On the flip side, residing overseas can broaden the scope of investment opportunities, with access to investments in both the United States and in your new country of residence.
Developing a well diversified investment portfolio is essential to navigate these complexities successfully. In this article, we explore some diversification strategies designed to mitigate risk and maximize opportunities for American expats living abroad.
- What is investment diversification?
- Understanding the challenges
- Investment diversification strategies for expats
- Final thoughts
What is investment diversification?
Investment diversification is a strategy that involves spreading investments across various asset classes, like stocks, bonds, real estate, and cash equivalents, to manage risk and optimize returns. By avoiding overreliance on any single asset class, investors seek to mitigate the negative effects of market fluctuations. Geographical diversification extends this approach by including assets from different regions, aiming to further enhance portfolio resilience. The goal is to create a well-balanced investment mix that can withstand economic challenges while tapping into diverse growth opportunities, globally. Regularly reviewing and adjusting the portfolio’s asset allocation is also advisable, to keep it aligned with your evolving financial goals and risk tolerance.
Understanding the challenges
Currency risk
Living abroad exposes US expats to currency fluctuations, as income and investments may be denominated in a currency other than that in which you’re normally spending. Currency risk can also impact the overall value of your assets.
Taxes and reporting
Americans living abroad may be subject to US taxation as well as taxes in their host country. Certain investments can trigger additional US taxes or reporting, such as investing in non-US mutual funds, which the IRS considers Passive Foreign Investment Companies (PFICs) and which incur complex reporting and new taxes.
Diverse economic environments
Different countries and regions have different economic outlooks and market dynamics. Adapting investment strategies to these diverse environments can enhance your portfolio resilience and performance.
Investment diversification strategies for expats
Global asset allocation
The most common and effective diversification technique is to invest across different asset classes, such as equities, bonds, and real estate, and across different countries and regions. A well-diversified portfolio reduces risk by mitigating the impact of downturns in any single asset class or region. However, this isn’t as simple as it sounds. Many investors will use exchange-traded funds that follow a country index, however this index may not be well-diversified. The Kospi50 index in South Korea for example has about 35% in information technology, most of this in Samsung, and so an investment in a fund that mimics this index is heavily weighted towards technology, which is a relatively volatile asset class. When investing through ETFs or mutual funds, it is important to understand the underlying investments in the fund and how they may impact your portfolio.
Currency diversification
Another common strategy for expats to manage currency risk is to hold assets in different currencies. This approach, known as currency diversification, is a risk management strategy aimed at reducing the impact of currency fluctuations on the overall value of an investment portfolio. The way it works, if one investment is devalued by currency fluctuations, it can be offset by the potential appreciation of investments denominated in other currencies. It is important to understand that currencies behave differently from equity markets. Stock values tend to increase over time with inflation and growth in underling corporate profits. However, currencies, at least those of major developed countries, tend to be mean-reverting – they fluctuate relative each other but do not strengthen or weaken compared to each other in a consistent trend. So, while currency diversification can help dampen volatility in a portfolio, a buy-and-hold currency strategy should not be expected to deliver good returns over the long-term. Currencies of emerging market countries also have unique risks, such as devaluation, that could have a significant impact on the value of the investment.
International real estate
Many expats choose to invest in real estate in their country of residence (or other international markets). Besides providing a home, real estate can provide potential appreciation and rental income, and investing in local properties may offer further benefits such as tax advantages, depending on local rules. Real estate investments can be made through a fund or by buying individual properties. A fund is easier to invest in, requires a smaller investment, and has the benefit of providing diversification through holding many properties, however the share price of the fund may be driven in part by factors unrelated to the values of the underlying real estate, such as investor perception of the real estate market. Investing in individual properties on the other hand allows a person greater control over their choice of investment, may have lower fees if the property is self-managed, but requires much more oversight and most likely a greater financial commitment.
Local investment opportunities
Expats have the opportunity to explore investment opportunities in their host country’s markets. Local knowledge can provide insights into industries and sectors poised for growth, offering opportunities that may not be apparent from a solely US perspective.
Diversified investment accounts
By utilizing a mix of brokerage accounts, retirement accounts, and other investments such as private equity, you can achieve a well diversified portfolio. Each account type comes with its own tax implications and advantages, contributing to a balanced investment strategy.
Regular portfolio rebalancing
Market movements can cause certain asset classes to outperform or underperform, leading to a deviation from your intended asset allocation in different asset classes. Rebalancing helps realign your portfolio with your original investment strategy. Periodically reviewing and rebalancing your investment portfolio allows you to maintain your desired asset allocation in line with your risk tolerance, financial goals, and evolving market conditions.
Final thoughts
Investing as an American living abroad requires a nuanced approach that considers the challenges and opportunities of diverse economic environments. Regularly reassessing and adjusting your investment strategy will ensure its relevance and effectiveness in the dynamic landscape of international living. Seeking advice from a financial advisor with expertise in both the US and international markets and working with expats is sensible to help you achieve long-term financial success while living abroad.
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.