How To Protect Yourself From Currency Shock

How To Protect Yourself From Currency ShockYes, HealthyWealthyExpat is back from a very long vacation.

Looking back at my last post, I see that it has been about 18 months since I last sat down to dump some random thoughts from my cerebral cortex into the laptop.

And while I’d love to take the time right now to reveal the various reasons for the extended hiatus, we’ll have to deal with that in the next post because we currently have a much more pressing issue to deal with.

You probably guessed it from the title: It has taken the infamous “Brexit” to jolt HealthyWealthyExpat out of his hammock to share something important with those patient enough to still be listening.

British Pound Drops Over 16% In 3 Months

Now that’s a headline that’s scaring a few people. It’s enough to put other concerns about Brexit related to residency, mobility, etc. far to the back of your mind isn’t it?

If you poke your nose out the door for a second, you may even be able to hear the collective angst of those millions of retired British expats who are dependent on pound-denominated pensions and investments for their monthly income.

It’s not a pretty sound.

On the other side of the proverbial coin, the resonance from all the British expats working overseas and sending money home for mortgage payments and retirement investments is more electrifying than the roar of the fans at a Liverpool-Manchester United match.

They just got a huge pay raise and a discount on the cost of their homes.

Now that’s a nice feeling.

We’ve been experiencing it ourselves over the past few years as the Canadian dollar has steadily declined from about par with the US dollar to about 76 cents today. As we get paid in dollar-pegged UAE Dirhams, this has been nothing short of a windfall.

But those of us on the positive side of these huge currency shifts shouldn’t gloat for too long.

Why? Because currencies have a habit of reversing course when we least expect it.

And if we want to preserve the gains we have made for future benefit, we need to make sure that we invest so that future currency moves in the wrong direction don’t negatively affect the investment portfolios we will be depending on to fund our lifestyles.

Protect Yourself

The fact is that the currency market is one of the most unpredictable markets in the world. It’s also one of the largest. Don’t even think you can outsmart it. Ignore all those ads for online currency trading academies promising $1500/day in profits, every day. Don’t ever forget that Mr. Market is far, far smarter than you.

A much better plan is to hold an internationally diversified portfolio of investments.

This is true whether you plan on retiring in your home country or on that exotic island that you are always dreaming about.

In either case, having foreign holdings in your portfolio will increase your returns when your currency is tanking because the foreign portion of your portfolio will rise in direct relation to the decrease in your home currency.

For an excellent example of how this works, take the CAD/USD exchange rate. Over the past two years, the Canadian dollar has lost about 15% against the USD. In that same time, the S&P500 US stock market index has gained 15%. Not bad.

However, if you owned an S&P500 ETF denominated in Canadian dollars, you would be happy to see that it gained over 30% – the extra 15% mirroring the loss in value of the CAD. Click on the image below to enlarge it and see what I mean:

cadusdvfv

This year will pan out quite similarly for pound-denominated foreign investments. The value of investments in foreign markets such as the US and Eurozone where the pound has lost ground will increase in direct proportion to the drop in the value of the pound.

Here is the chart comparing the GBP/EUR exchange rate to an ETF that tracks the European stock indexes (not including the UK) over the past 6 months. You can clearly see how the European ETF has increased in value about the same percentage as the pound has declined.

gbpeurieux

Click on image to enlarge.

More importantly for those retired folks depending on disbursements from their investments to fund their lifestyles, the income from those investments, whether in the form of dividends, interest, or rents, will also increase accordingly.

So if you are one of those lucky British retirees living a life of leisure in southern Spain, and you have a good portion of your retirement investments in holdings that pay dividends in Euro, US dollars, or any number of other currencies, you’re still kicking back in your beach chair with not a worry in the world. Your income probably hasn’t changed much.

If you are retired and living in the UK, then your income in GBP will have actually gone up an amount matching that 16% in the headline above. Nice work. This will help you deal with the inflation on imported goods such as food that is already starting to occur, as reported in this article in the Economist.

What Percentage Should I Allocate to Foreign Holdings?

This is a great question, one best answered by Andrew Hallam in “The Global Expatriate’s Guide to Investing“.

Hallam notes that if you are planning on retiring in your home country, then an approximately 40% allocation to foreign holdings is prudent. This could be done through investing in a global stock market ETF or by putting 20% in a US market ETF and the other 20% in an international developed markets (not including the US) ETF.

However, if you are planning on retiring in a foreign country, he states that you may want to hold more like 60% of your portfolio in international investments.

Sound too complicated? It’s not. I suggest that you get a hold of Hallam’s book and start by reading the section aimed at your nationality. In fact, every expat interested in their financial future should read every page of this book.

You can also find out more information and interact with his online community through his website.

Note: While Hallam’s book deals with portfolios that hold stocks and bonds, the same concept applies to any other investments that you have, such as real estate: aim to have a good portion of your holdings and income denominated in the currency of the country where you will be spending it.

Are There Any More Ways to Protect Myself?

Yes, there are. Here are two of them:

Forward Contracts

If you make regular international transfers and are concerned that the exchange rate might deteriorate over the next few months, you can “lock in” the current rate with international currency transfer company such as Currencies Direct.

For a small deposit, you can be assured that your regular payment won’t be affected by a massive shift in the exchange rate. Those of you who believe that the pound has much more to fall might like to consider this option.

Gold

Some investors, myself included, like to keep a small percentage of their investments in gold or gold stocks.

Gold can act as an excellent hedge against currency shifts. For example, we bought some gold a few years back when it was around $1500 US an ounce. When you look at the price of gold nowadays (about $1275/ounce), you might at first glance think that we made a bad investment.

However, we don’t live in the US, nor do we travel there regularly. We value our portfolio in Canadian dollars. With the large drop in the Canadian dollar over the past few years, that gold investment is actually worth more in Canadian dollars today than when we bought it.

And what if the reverse had happened and the USD had weakened? Well, gold usually does very well when the dollar declines, so we would have been protected in that case as well. 😎

How about you? How do you protect yourself from currency shock?  Do you have any other strategies that we could learn from? Share your wisdom with our community by posting your comments below.

Comments

  1. Thank you for your advices! Very useful!

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