Author Topic: Ex-Pat FIRE - Currency Risk/Hedge  (Read 627 times)

zombiehunter

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Ex-Pat FIRE - Currency Risk/Hedge
« on: July 26, 2020, 09:07:44 AM »
We're closing in on a (lean)FIRE Target for June 2021, and will be relocating to France - where our mortgage and living expenses expenses will be in Euros, but the 'Stache is a diversified basket of Vanguard ETFs in taxable and tax advantage accounts in USD.  I've become increasingly concerned about my blind spot to currency risk, given the risk that the USD declines as against the Euro, when we have large, fixed, monthly costs in Euros.  The effect of that would be to exacerbate SORR.   

Basics:
  • 70/30 Stock/Bond+Cash portfolio, in the aggregate = 45% US, 25% INTL, 25% Bond, 5% cash 
  • Mortgage in France @ 1.8% fixed 25-year = 2500 EUR in fixed monthly costs, 23 years remaining
  • Intent is to semi-FIRE as self-employed (renting 2-4 BNB rooms) and self-sufficient (growing 50% of our food) with Mustachian values

Other than 6-10 months of Mortgage payments held in EUR, our assets / holdings are all in USD.  Practically, I am planning on wiring USD to EUR 2-4 times semi-annually, using Transfire Wise - which will effectively dollar-cost-average the currency exchanges.

Previously I had considered currency risk as partly addressed by holding International equities, such that if USD declines relative to other currencies, returns for ETFs held in USD would be sufficiently compensated.  Is this generally considered the most Mustachian/Boggleheads, passive-investor strategy to hedge currency risk?

However, my primary international holding currently (VEU) is weighted only 40% to Europe (and VT is just 17% Europe).  In the event that the USD declines as against most currencies (and not specifically against EUR), is holding International equities sufficient to hedge the currency risk if the INTL equities are just 25% of total portfolio?  I would prefer to avoid holding around 50/50 as between US/Intl equities - e.g. it seems that increasing Intl holdings just to increase the currency hedge opens you to greater risk of the Intl equities under-performing (separate from any currency changes).

I am considering two options (1) increasing Intl and tilting Intl equities towards Europe/Euro(VGK), but I would not otherwise be interested in investing in this ETF were it not for the currency concern, and (2) more complicated/expensive hedged ETFs.  On this second point, I am generally not familiar or well-versed with the currency issue to understand what exactly I would be looking for.  For example, there are hedged S&P 500 ETFs and there are hedged against a particular currency (including EUR), and a hedged MSCI Eurozone ETF.  Generally, I understand that the currency in which bills/fixed costs are due should be currency that is hedged, so think the EURO fund might be correct:

https://www.ishares.com/us/products/268708/ishares-currency-hedged-msci-emu-etf


tl/dr = Any thoughts/recommendations for dealing with currency risk when investments are in USD and fixed FIRE expenses are in Euros?
« Last Edit: July 26, 2020, 09:31:40 AM by zombiehunter »

helloyou

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Re: Ex-Pat FIRE - Currency Risk/Hedge
« Reply #1 on: July 26, 2020, 09:40:22 AM »
U got the same problem. I decided to split my asset into half GBP and half USD.

zombiehunter

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Re: Ex-Pat FIRE - Currency Risk/Hedge
« Reply #2 on: July 26, 2020, 09:55:25 AM »
U got the same problem. I decided to split my asset into half GBP and half USD.

What do you mean by split your asset into GBP?  You hold GBP-denominated securities?  USD denominated securities that track GB equities/bonds?  GBP cash?
« Last Edit: July 26, 2020, 10:09:13 AM by zombiehunter »

helloyou

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Re: Ex-Pat FIRE - Currency Risk/Hedge
« Reply #3 on: July 26, 2020, 11:00:49 AM »
Yes split with gbp currency or stock. Usually FTSE.

Then the other half US stock and currency.

The S&P such as the vanguard VUSA even if its traded in GBP is indexed to USD so I also invest in it but I know it'll move with GBP/USD fluctuation

Tyler

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Re: Ex-Pat FIRE - Currency Risk/Hedge
« Reply #4 on: July 26, 2020, 04:42:13 PM »
Hi Zombiehunter.

I don't know the right answer to your question, but I can provide some tools that will help you explore it in more depth. For example, here is how I would model the historical withdrawal rates of your situation:



For reference, all of the asset options are naturally unhedged and when set to "France" the tool automatically translates the returns to French currency (Euro when available, francs before that) and local French inflation. You can also tweak the inputs in the above link to study the performance of any asset allocation you like, including ones with French or European stocks and bonds. And there are also many more calculators to play with that work the same way, so there should be no shortage of data.

BTW, if you're interested in how withdrawal rates differ by country you may also find this article informative: Your Home Country Is Inseparable From Your Withdrawal Rate

I hope that helps. And congrats on your impending FIRE and big move!
« Last Edit: July 26, 2020, 04:49:55 PM by Tyler »

zombiehunter

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Re: Ex-Pat FIRE - Currency Risk/Hedge
« Reply #5 on: July 27, 2020, 07:56:27 AM »
Hi Zombiehunter.

I don't know the right answer to your question, but I can provide some tools that will help you explore it in more depth. For example, here is how I would model the historical withdrawal rates of your situation:



For reference, all of the asset options are naturally unhedged and when set to "France" the tool automatically translates the returns to French currency (Euro when available, francs before that) and local French inflation. You can also tweak the inputs in the above link to study the performance of any asset allocation you like, including ones with French or European stocks and bonds. And there are also many more calculators to play with that work the same way, so there should be no shortage of data.

BTW, if you're interested in how withdrawal rates differ by country you may also find this article informative: Your Home Country Is Inseparable From Your Withdrawal Rate

I hope that helps. And congrats on your impending FIRE and big move!

Thanks Tyler, that's very helpful - I'll play around with the tool and see if I can come up with something.

Based on some limited reading and research, I'm considering implementing something like the below to provide a hedge against the falling dollar in general and specifically against the Euro:
  • 40% Vanguard Europe (VWO)
  • 40% Vanguard Emerging Markets (VGK)
  • 20% Gold (IAU)
This would be something like a 10% side basket to my main taxable portfolio, ideally built up to 1-2 years worth of living expenses, to be drawn on if the dollar falls so that I don't need to touch the regular portfolio and hope that the value of the dollar recovers in that time.

Other than gold, this portfolio is roughly in line with my investing goals of maintaining low-cost, index funds - rather than some sort of levered or hedged ETF with higher fees.  I have never held gold before or been interested in holding it, but from what I understand, it should offer offsetting returns if the value of the Dollar declines.  If this ends up being 10% of my portfolio, it would only be 2% of total so query if that is enough to move the needle at all. 

The 40% Europe basket is specifically to hedge against the Dollar falling against the Euro - however there is some risk that USD and EURO fall together as they face similar macro factors right now. 

The 40% EM basket is to hedge against the Dollar falling in general - from what I understand, the falling dollar would be most beneficial to these markets as opposed to the Euro market. 

As an additional tool to hedge against my currency risk, thinking of creating an account in France - I think our bank has some kind of product that permits an allocation between a reasonably high interest savings account (1.5%?) and equity market exposure (not sure if French or Euro markets).  Ideally that would hold another 1-2 years of living expenses.  However, holding the Vanguard Europe basket described above might not be necessary if holding this in Euros - I could then increase the EM and Gold baskets to something like 60/40. 

This would result in the following draw down sequence over the next 5+ years:
  • Selloff taxable bond holdings (VTEB) to glide down the bond allocations
  • If currency rates exceed [threshold TBD], start to tap into Euro denominated holdings
  • If currency rates continue to exceed [threshold TBD], tap into Vanguard EM/Gold hedge holdings described above that should be up
That should be roughly 5 years to avoid touching my primary US equities.  Even if it just buys 5 years without having to touch the US equities (e.g. there is not much recover in the dollar during that time), it should be helpful for SORR to avoid any withdrawals during that period. 

Any other expats dealing with this issue?
« Last Edit: July 27, 2020, 08:21:00 AM by zombiehunter »

zombiehunter

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Re: Ex-Pat FIRE - Currency Risk/Hedge
« Reply #6 on: July 28, 2020, 09:42:11 AM »
Bump -- would be great to hear how other Mustachians are treating currency risk.  After thinking through this the past few days, I'm mostly back to where I started (using International index funds) to hedge rather than any kind of hedged ETF or Gold.  I'm just going to start tilting my international holdings toward Europe (for the specific USD-Euro exchange rate risk) and EM (for the general USD exchange rate risk) as I make new contributions.  I should probably get my equity holdings closer to 50/50 US/Intl. 

Looking back over the past 5-10 years, the Euro to USD exchange has gone from a low of $1.04 (Dec 2016) to, on the other side of the spectrum, $1.24 (Jan 2018), $1.39 (April 2014), and even $1.45 back in 2009.  From where it's at today ($1.17), this would represent a change of -6%, -19% and -24%. 

Seems like those higher/worse figures could be a crippling SORR blow if they reoccur during the next 5-10 years.         
« Last Edit: July 28, 2020, 09:51:21 AM by zombiehunter »

PDXTabs

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Re: Ex-Pat FIRE - Currency Risk/Hedge
« Reply #7 on: July 28, 2020, 12:08:55 PM »
Bump -- would be great to hear how other Mustachians are treating currency risk.

I'm still in the accumulation phase and deal with currency risk by staying as close to 100% equities (VT) as possible. Obviously, when it comes to draw down, I might want some bonds. I'm in the same boat too, earning USD, hope to be spending Euros or GBPs.