Forex poses a genuine risk to expatriates though not in the way you may expect. According to the latest Office of National Statistics (ONS) figures over 3.5 million people have emigrated from the UK over the last 10 years. The vast majority of whom hold pensions that may now bear a greater risk to their retirement dreams than they are aware of. There are, however, a few simple tricks that can be used to either offset or nullify this risk. To this end allow us to answer some frequently asked questions (FAQs) on the matter;
- What is forex?
- What pensions are effected?
- How big a risk is forex to your pension?
- How to mitigate foreign exchange risk
- Why investment currency denomination is not always enough
- What is hedging and should you use it
- Securing the best forex rates
For example, the euro has depreciated almost 17% against the US dollar over the last year and almost 25% from the market top to bottom
The most important aspect to reduce forex risk is to alter your financial plans accordingly to account for it. Ideally, your choice of currency should be aligned with your objectives. Therefore, if you intend on retiring in Spain you should calculate your retirement goal in euros. This may then have a baring as to how you invest.
Finally, if you are comfortable with taking some risk it is also possible to secure some of the best forex rates possible
It has risen 5.2% from 3,284.81 to 3,455.80.
However, if someone invested in an unhedged USD share class the index would be priced in dollars. With the euro weakening 17% over the same period (see chart in how big a risk is forex to your pension) then the investment would have lost over 11%. By contrast, a hedged version would has returned an increase of 5.2% (excluding costs)
There are downsides though including both the cost of hedging and the loss of any potential gains. These, however, should be seen as the price for gaining more certainty. Also, removing some variables can have the opposite effect and increase risk. If you are investing in the stock market then, all else being equal, they perform better with a weaker currency over a stronger currency (exports become better value etc). As such, you can find that in falling markets losses can be offset by a stronger currency and vice versa. This can reduce the volatility i.e. risk involved.
Whether you use hedging will be down to the level of risk that you are comfortable taking. Those with a lower risk tolerance should generally use hedging, if required, on investments that pay fixed levels of interest. Other types of investments can benefit from not being hedged as mentioned earlier. The exact strategy will depend on the investments held. For any queries you should seek specialist advice as it should be tailored to your requirements
Therefore, getting the best forex rate when converting British Pounds (GBP) to US Dollars (USD) involves selling GBP near a rate of 2 and buying when the rate is close to 1.4. Doing this should boost your pension returns but comes with a risk. The risk is that either the rate never materialises, the rate continues to get worse, or that you do not invest in an asset because the currency it is denominated in isn’t near it’s best rate. In the above example, there is nothing to say the dollar doesn’t get a lot stronger, for example reaching parity with the pound, or vice versa. Regarding investment choice, the exchange rate won’t normally make or break the decision on whether to invest or not