Hedging Currency Risk After Retirement

[Gumby]

This is my view also. The next big crisis will be currency devaluation.

So which currency will become more valuable vis a vis the dollar? I would want to buy that.



Edit: This was hived off from the 100% equity allocation thread. I think the topic is worth a thread of its own.

 

[Danmar]

So which currency will become more valuable vis a vis the dollar? I would want to buy that.

Maybe a currency backed by natural resource commodities, very strong financial sector, and a responsible government? Not many of those around.

 

[Gumby]

Maybe a currency backed by natural resource commodities, very strong financial sector, and a responsible government? Not many of those around.

Perhaps CAD or AUD.

 

[Danmar]

Perhaps CAD or AUD.

Good point. I think I will leave all my money in CAD.

 

[Gumby]

Good point. I think I will leave all my money in CAD.

As would I, if I were in your place.

Edit to add: Now this has got me thinking -- if one has retirement income denominated in USD (such as Social Security or a US based pension), would it be possible for an individual to engineer some sort of currency swap to cover potential declines in the USD versus one's currency of expenditure? Merely shifting existing USD assets to a foreign currency seems relatively straightforward by comparison.

 

[MichaelB]

It makes sense to match income and expenses in the same currency. Loss of purchasing power that would result from declining currency and economic activity can be minimized by investing in a global portfolio of unhedged equities and fixed income. Hedging currency makes sense if one has a specific income or liability imbalance, but otherwise is very risky.

 

[Gumby]

It makes sense to match income and expenses in the same currency. Loss of purchasing power that would result from declining currency and economic activity can be minimized by investing in a global portfolio of unhedged equities and fixed income. Hedging currency makes sense if one has a specific income or liability imbalance, but otherwise is very risky.

I agree that trading currencies is difficult and risky. I'm thinking of the hypothetical US retiree who now lives in, say, Mexico. That person receives social security in USD but pays rent and groceries in pesos. I'm wondering about the logistics of how he or she could hedge against the currency risk to that income stream.

 

[Danmar]

It makes sense to match income and expenses in the same currency. Loss of purchasing power that would result from declining currency and economic activity can be minimized by investing in a global portfolio of unhedged equities and fixed income. Hedging currency makes sense if one has a specific income or liability imbalance, but otherwise is very risky.

Agree. In our case now that we have purchased a home in Arizona, we will have recuring USD expenses. I am thinking about buying some Cdn equities that pay dividends in USD to cover these expenses. Problem is there are only a few such companies in Canada and I don't care much for their future prospects. I guess if the USD continues to depreciate against the CAD I will only be further ahead. Incidently the exchange rate on the purchase was better than par from CDN perspective.

 

[MichaelB]

Agree. In our case now that we have purchased a home in Arizona, we will have recuring USD expenses. I am thinking about buying some Cdn equities that pay dividends in USD to cover these expenses. Problem is there are only a few such companies in Canada and I don't care much for their future prospects. I guess if the USD continues to depreciate against the CAD I will only be further ahead. Incidently the exchange rate on the purchase was better than par from CDN perspective.

Now you have an asset in a foreign currency. As the US$ loses value the expense of maintaining the house falls but so does its value in Loonies. If you have part of your portfolio in global equities it should not make a difference. A US$ based investment that responds to global growth and pays a dividend is not a bad option to hedge the US$ expense. iShares Dow Jones Select Dividend (DVY) is one such option.

 

[MichaelB]

I agree that trading currencies is difficult and risky. I'm thinking of the hypothetical US retiree who now lives in, say, Mexico. That person receives social security in USD but pays rent and groceries in pesos. I'm wondering about the logistics of how he or she could hedge against the currency risk to that income stream.

This is a complex situation and there is no simple answer. If the retiree has no other source of income sudden changes in exchange rate can leave them financially exposed with few or no options. The only real strategy here would be to save enough to set aside some cash / short term funds in both currencies that can be used in times of financial or personal distress.

If they do have assets, such as US$ retirement funds, they really need to convert some into assets domiciled in Mexico. Sovereign bonds and the domestic stock market are two options. In reality, this lowers one risk and introduces another. Just as most people here in the forum recommend one year of expenses in an emergency fund, the same applies to our retiree in Mexico, but in local currency.

For me, though, the greatest risk still comes from economic development. Low cost of living around the world is the result of low standards of living, and as we see countries develop, the standards improve but the costs rise along with that. This is an amazingly positive development for humanity, but it will not be good for our retiree looking for inexpensive living.

 

[Danmar]

Now you have an asset in a foreign currency. As the US$ loses value the expense of maintaining the house falls but so does its value in Loonies. If you have part of your portfolio in global equities it should not make a difference. A US$ based investment that responds to global growth and pays a dividend is not a bad option to hedge the US$ expense. iShares Dow Jones Select Dividend (DVY) is one such option.

Yes. Problem is I wouldn't get the beneficial tax treatment of dividends. The other problem is that these CDN companies are paying dividends in USD for a reason, ie they receive USD revenue. Thus if USD weakens so does their revenue and since their costs are often at least partly CAD, their earnings weaken. May just be better to keep everything in CAD. I don't care about the Arizona house being denominated in USD. We got such a good deal and I really don't care what it ends up being worth.

 

[Ed_The_Gypsy]

My opinion:
Keep it simple.
Keep things in your own currency.
Both points form personal experience and considerable stupidity.

 

[MichaelB]

Yes. Problem is I wouldn't get the beneficial tax treatment of dividends. The other problem is that these CDN companies are paying dividends in USD for a reason, ie they receive USD revenue. Thus if USD weakens so does their revenue and since their costs are often at least partly CAD, their earnings weaken. May just be better to keep everything in CAD. I don't care about the Arizona house being denominated in USD. We got such a good deal and I really don't care what it ends up being worth.

Interesting. I can see how that option would be attractive. Hope it works out. True, if the loonie strengthens it hurts, but if it not a significant expense item or asset it probably doesn't matter. Trying to project currency value over time is very difficult, and I think it is mostly time wasted. Global businesses don't attempt to make currency bets (exception finance industry) and focus their efforts at protecting the currency value of their cash and profits.

 

[Surewhitey]

What I do is purchase company stock of foreign companies (like PGH, TOT, FTE) that pay divys in euro / cad and I get the equivalent in usd based on current exchange rates.

The other we have done is we budgeted coming to Mexico on 11p/1usd. We got here and it spiked to 13, then 14. We accumulated 6 months expenses / rent and probably averaged 13.3-13.6 / 1usd. It's now down to 12.75 and we're wrapping up our time here. Works great as long as you have a place to store it.

 

[obgyn65]

Not that simple. Let's say you have 500,000 euros in a German bank because you used to work in Europe. All the money is in CDs, interest about $20k a year, declared to the IRS. When do you bring the money back to the US? Would you wait 5, 10 years? Do you bring the money back to the US at all?

My opinion:
Keep it simple.
Keep things in your own currency.
Both points form personal experience and considerable stupidity.

 

[Danmar]

My opinion:
Keep it simple.
Keep things in your own currency.
Both points form personal experience and considerable stupidity.

I agree. Simply plan to buy USD when I like the rate and hold it in a checking accout till it is used up. My exposure is minimal I think.

 

[MichaelB]

Not that simple. Let's say you have 500,000 euros in a German bank because you used to work in Europe. All the money is in CDs, interest about $20k a year, declared to the IRS. When do you bring the money back to the US? Would you wait 5, 10 years? Do you bring the money back to the US at all?

Where, or in what currency, do you plan to use that money? If in a hard currency, I would leave it there to minimize exchange exposure.

 

[MichaelB]

My opinion:
Keep it simple.
Keep things in your own currency.
Both points form personal experience and considerable stupidity.

Ed, simple is better. My experience as well, and I seriously doubt that last part...

 

[FIREd]

I own some real estate in Europe. That's my main hedge against a dollar decline (I own very few foreign equities). In order to cover the expenses associated with that real estate, I keep some cash in a checking account in Europe. In the worst case scenario, selling or renting out those real estate properties is a possibility.

 

[Ed_The_Gypsy]

Ed, simple is better. My experience as well, and I seriously doubt that last part...

It's like the Ziggy cartoon says: "Good judgement comes from experience, and experience comes from bad judgment."

 

[Ed_The_Gypsy]

Not that simple. Let's say you have 500,000 euros in a German bank because you used to work in Europe. All the money is in CDs, interest about $20k a year, declared to the IRS. When do you bring the money back to the US? Would you wait 5, 10 years? Do you bring the money back to the US at all?

Good point. I never considered that possibility.

Like Mike says,

Where, or in what currency, do you plan to use that money? If in a hard currency, I would leave it there to minimize exchange exposure.

I second that.

What do you eventually plan to do with it? Are you ever going to leave the US? (By the way, it is OK if you don't know right now. You have lots of time.)

 

[MichaelB]

It's like the Ziggy cartoon says: "Good judgement comes from experience, and experience comes from bad judgment."

Well, if experience comes from bad judgement, then I got a whole lot of experience

 

[nun]

Unless you have expenses in a foreign country I see no need to hedge the dollar. If you do have foreign expenses I'd buy foreign stocks or appropriate US international funds as a hedge

 

[Danmar]

Unless you have expenses in a foreign country I see no need to hedge the dollar. If you do have foreign expenses I'd buy foreign stocks or appropriate US international funds as a hedge

Yes I think that was the question. Income and expenses in different currencies. Not as easy or as simple to hedge as you might think at first.

 

[nun]

Yes I think that was the question. Income and expenses in different currencies. Not as easy or as simple to hedge as you might think at first.

The difficulty is two fold; finding an appropriate hedge and then dealing with the tax consequences.