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Managing Currency Risk for U.S. Expat Investment Plans
November 29, 2022
Due to FATCA (Foreign Account Tax Compliance Act), PFIC (Passive Foreign Income Company) and other regulations, U.S. expats living abroad are almost compelled to maintain their investment accounts within the U.S. jurisdiction. The first challenge is finding a U.S. based custodian that will accept non-U.S. residents. Granted that they can find a U.S. based custodian to service their investment accounts based on their non-U.S. residency, the next challenge is in what currency denomination the investments will be maintained. It’s crucial for U.S. expats to comprehend currency risk and how it affects investing. For investors, currency concerns are frequently one of the most frustrating and poorly understood problems. This is particularly true for dual citizens and Americans living overseas whose expenses, liabilities, salaries and other sources of income and expenses are frequently expressed in currencies other than the USD. In this article, we outline a few simple guidelines that investors can utilize to help them make educated decisions on the currency denomination of savings and investments.
What is Currency Risk?
Currency risk (or FX risk) refers to the potential for gains or losses resulting from fluctuations between various currencies. Currency risk can affect expats, multinational companies, governments, tourists, banks, and everyone who relies on other countries for products and services. Taking on some risk is unavoidably necessary in order to get solid long-term growth in a well-balanced investment portfolio. But as investors, our objective should be to increase investment returns with minimal risk as possible. Unfortunately for expats, fluctuations in currency exchange rates (FX Rates) can add to the risk factor of investing and saving for their future. Fluctuations in the exchange rate between both the currency denomination of our investments and the currency in which we use for daily living in our country of residence may significantly reduce or even reverse positive investment outcomes.
Can I reduce currency risk?
By concentrating on a balance between “Life Assets” and “Life Liabilities,” we may significantly reduce currency risk without having to give up much investment returns. “Life Assets” are assets such as financial investments and savings that we build and grow throughout our earning years for our future needs in retirement income, education and other financial goals. Meanwhile, “Life Liabilities” are living expenditures such as mortgage payments, raising a family, credit card debts, other liabilities, and current and future expenses. “Life Assets” are usually eventually liquidated to cover future “Life Liability” needs such as retirement or education plans.
These “assets” and “liabilities” each have a currency denomination tied to it. Stocks, ETFs and other securities are priced in the issuer’s native currency. However, bonds are issued in the currency in which they pledge to make their interest payments and principal redemptions. Certain assets, most particularly gold and commodities, have no fixed denomination and are openly exchanged in a variety of markets and currencies around the world. They are not pegged to the currency of any nation. It is highly probable that U.S. citizens abroad will suffer the unfavorable consequences of currency risk when “Life Assets” that are created to satisfy “Life Liabilities” are valued in various currencies.
How to hedge against uncertain geography
It is normal for U.S. expats to be uncertain of where they will settle or length of stay. In these situations, projections should be made based primarily on the most plausible scenarios, and then create a portfolio that is still diversified across a variety of currencies, so that choices about one’s career and retirement are not influenced significantly by changes in the relative value of different currencies. If our geographic future and “Life Liabilities” are unpredictable, we should avoid being reliant on a single currency.
Should I safeguard myself from the declining dollar?
U.S. expats usually voice their serious concern on the future of the U.S. dollar. Consequently, they frequently look for currency investment plans that guarantee returns in case the value of the dollar drops. Unlike stocks or bonds, currencies are a zero-sum investing activity, meaning that for one currency to grow, another must decline. After the middle person receives their share, betting on the uncertainties of currency fluctuation becomes a gamble for the investor as we try to beat the odds of losing.
Meanwhile, investments in stocks and bonds typically increase in value over time. One stock does not necessarily need to decline for another to increase. Currency values are largely influenced by variables and unforeseen long-term economic developments, not to mention sovereign and geopolitical issues, which makes them very challenging to forecast, especially for the long term. Using the above-described framework of “assets” and “liabilities” to arrange your currency exposure makes more sense. A suitable native currency-focused investment strategy will safeguard you if the dollar does suffer a prolonged slump and you intend to reside elsewhere.
However, if you are planning to return to the U.S., you will find that you are comparatively protected from the US dollar’s decline because most of the products and services you will be acquiring will be priced in U.S. dollars anyway. As a result, the U.S. dollar’s decline will have very little effect on your actual financial situation.
As always, navigating through the complexities of cross-border financial planning can be quite daunting and is best left for cross-border financial professionals to manage.
Disclaimer:
- The information provided is for educational purposes only and does not constitute personal financial, tax or investment advice and should not be relied on as such. It does not take into consideration any investor’s particular investment objectives, strategies, time horizon, and tax or legal status. Abacus Wealth International (AWI) does not provide tax or legal advice. Please consult a tax or legal professional for corresponding tax and legal advice.
- All material and content have been obtained from sources believed to be reliable. AWI does not guarantee the accuracy of the information provided and shall not be held liable for decisions based on the foregoing information.
- All examples of graphs, financial products and historical returns contained in the foregoing material are for illustration and educational purposes only and shall not be deemed as financial advice or recommendation. Past performance is not indicative of any future investment returns.