Relocating abroad is an exciting prospect, offering new opportunities for personal and professional growth and cultural experiences. However, as an American expat, moving abroad also brings challenges, particularly when it comes to managing your investments. Navigating different tax laws, financial regulations, and market conditions can complicate investment risk management. Understanding your risk tolerance, which refers to how much volatility you can handle, and your risk capacity, or how much risk you can realistically afford, is essential to shaping a personalized investment strategy. In this article, we’ll explore strategies to manage these risks and support your financial security abroad.
Assessing your risk capacity and comfort levels
Your risk capacity is highly personal and influenced by your financial situation, investment goals and the timescale to achieve them. If you anticipate needing to access your funds in the near term, your capacity for risk will be lower. Conversely, if you are focused on long-term goals, you may be better able to ride out more volatile investments that can provide a better return over time.
Required risk refers to the level of risk necessary to achieve your financial goals. It’s possible that this requirement may not align with your personal comfort levels or risk tolerance. Collaborating with an expat financial advisor can provide valuable insights, helping you find the right balance between required and comfortable risk, and ensuring that your investment strategy is tailored to your unique needs and circumstances.
The risk of double taxation
One of the first steps to effectively managing your investments abroad is understanding the tax implications in both the US and your new country of residence. As a US citizen, you are required to file US taxes on your global income, no matter where you live. This includes investment income, such as dividends, capital gains, and interest.
You’ll also need to familiarize yourself with the tax regulations of your new country. Some countries may impose additional taxes on your foreign investments, and others may not recognize the tax-advantaged status of US retirement accounts like IRAs or 401(k)s. This could result in double taxation on your investment returns, even if there’s a tax treaty between the US and the country where you reside.
Some countries also have a wealth tax, or a tax on assets rather than income, or an inheritance tax; the USA doesn’t tax assets, except as a property tax, and has an estate tax rather than an inheritance tax.
A cross-border tax advisor can help you understand your tax liabilities and how to mitigate the risk of double taxation by claiming IRS provisions such as the Foreign Tax Credit and the Foreign Earned Income Exclusion.
Diversification across markets and currencies
As an expat, currency fluctuations, political instability, and both local and global economic conditions can all impact your portfolio.
Currency risk, in particular, can become a significant factor for American expats. Your investments may be in US dollars, but if you’re earning and spending in a different currency, exchange rate fluctuations could impact the real value of your investment returns.
Diversifying your portfolio across different markets and currencies can help mitigate these risks.
In addition to geographic and currency diversification, it’s important to diversify across different asset classes. Limiting your portfolio to a single asset class, such as stocks, can expose you to unnecessary risk. Different asset classes—like bonds, real estate, and commodities—often respond differently to economic changes, making your portfolio more resilient.
US brokerage account closure risk
Many American expats struggle to maintain their US brokerage accounts once they move abroad. This is because US financial institutions may restrict or close accounts for expats due to the burden of complying with regulations like Know Your Client and anti-money laundering rules. An expat financial advisor will understand the unique regulatory hurdles overseas Americans face and provide tailored solutions to help you maintain your US-based investments.
Watch out for passive foreign investment companies (PFICs)
American expats should be cautious about investing in foreign mutual funds, ETFs, and individual pension plans, as the IRS may classify these types of offshore investments as Passive Foreign Investment Companies (PFICs). PFICs come with punitive US tax treatment, including higher tax rates and complex reporting requirements, which can significantly eat into your investment returns. If you inadvertently invest in a PFIC and do not report it properly to the IRS, you could face significant tax penalties, further complicating your financial situation.
Retirement planning risks
If you’ve built up savings in US retirement accounts like IRAs or 401(k)s, managing these accounts can become complicated once you move abroad. Some foreign countries may not recognize the tax-deferred status of US pension plans, meaning withdrawals, contributions, and gains could be taxed in your new country of residence.
In many cases, tax treaties between the US and other countries provide relief by ensuring that your US retirement income is only taxed once. However, the rules vary depending on the treaty, and it’s essential to understand how your specific situation will be affected.
Final thoughts
Managing your investments as an American expat requires careful planning and a broad understanding of the risks involved. It’s important to have a personalized strategy that aligns with your personal goals, risk tolerance, and capacity, while also addressing the specific risks related to your expat experience. By making informed decisions and consulting with experts in cross-border financial planning, you can protect your portfolio and ensure long-term financial security 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.
