Risks buying intl denominated in non-home currency?

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greg219
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Joined: Sat May 26, 2012 2:57 pm

Risks buying intl denominated in non-home currency?

Post by greg219 » Tue Mar 24, 2015 12:20 am

Dear fellow Bogleheads,

Short version of my question: Does it matter for any relevant aspect in which currency a global fund in one's portfolio is denominated? Or, similarly: If I have a home bias in currency X, but can access a global fund in currency Y much cheaper, are there any reasons why I shouldn't buy it in Y and convert to X at sell point (assuming I already own some amount of Y)?

(I think it doesn't matter. And that I'd be fine buying it in Y.)

Long version:

I'm a permanent US resident but not citizen with a pretax 401k (currently in the low 6 digits). I'm likely to move back to my Scandinavian home country within 5 years, which is why I have a home bias in a small non-USD/non-EUR currency. I've for long been punting on deciding what to do with my 401k when moving back. The extreme alternatives are:

A) Roll over to an IRA and leave the money in the US until I'm 59.5 and at that point start withdrawing and paying US taxes.
B) Take everything out at move time and pay US taxes and the 10 % penalty up front.

For some reason, I always intuitively weighed the home bias heavily (not wanting to be too heavy in USD) which have led me to think that the 10 % penalty is acceptable and pick B. But, recent thoughts have led me to reconsider and lean towards A.

Why?

We know that we benefit from intl equity exposure (20-40 % or so) regardless of home bias. And there's no extra currency risk in buying+selling intl in USD and converting it to my home currency at sell time vs buying+selling intl in my home currency from the start (assuming they track the same index) [this is really the part I'm not sure about]. So I might as well use my 401k (to-be-IRA) money for the intl part so that I can avoid the 10 % penalty.

What are your thoughts? Anything I'm missing?

Many thanks in advance!

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ogd
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Re: Risks buying intl denominated in non-home currency?

Post by ogd » Tue Mar 24, 2015 12:45 am

greg219 wrote:Dear fellow Bogleheads,

Short version of my question: Does it matter for any relevant aspect in which currency a global fund in one's portfolio is denominated? Or, similarly: If I have a home bias in currency X, but can access a global fund in currency Y much cheaper, are there any reasons why I shouldn't buy it in Y and convert to X at sell point (assuming I already own some amount of Y)?

(I think it doesn't matter. And that I'd be fine buying it in Y.)

This is correct. Only the underlying assets matter. The sale in USD and conversion to [some kind of] kroner would cancel out the currency volatility, assuming the conversion is done fast enough to make the volatility after sale negligible.

Your plan sounds fine, assuming there isn't a regulation forcing you to liquidate the IRA. Investing in the US is much cheaper and easier, and I say that not because of ignorance but having had the occasion to witness first hand the sorry state of investing in Europe (annoying & expensive brokers, no decent mutual funds, fragmented markets making ETFs a pain, etc).

TedSwippet
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Re: Risks buying intl denominated in non-home currency?

Post by TedSwippet » Tue Mar 24, 2015 7:17 am

greg219 wrote:...The extreme alternatives are:
A) Roll over to an IRA and leave the money in the US until I'm 59.5 and at that point start withdrawing and paying US taxes.
B) Take everything out at move time and pay US taxes and the 10 % penalty up front.

For some reason, I always intuitively weighed the home bias heavily (not wanting to be too heavy in USD) which have led me to think that the 10 % penalty is acceptable and pick B. But, recent thoughts have led me to reconsider and lean towards A.

Cross-border pensions are tricky. Worst case, your pre-tax IRA can become fully taxable annually to your home country when you move back. Some countries recognize foreign pensions automatically, others do so only if covered by the relevant tax treaty.

You need to investigate your home country's tax laws regarding a) offshore holdings, and b) foreign pensions. And you need to know if your home country has a tax treaty with the US, and if yes then what does it say about foreign pensions?

As a secondary consideration, consider the possibility of US estate tax on your IRA after you cease being a US LPR. Once no longer an LPR (and assuming you don't become a US citizen) you become a full-on NRA, and NRAs only have a $60k allowance for US estate taxes. The number of US estate tax treaties is much lower than income tax treaties. Sweden is notably absent from the list.
Last edited by TedSwippet on Tue May 19, 2015 5:37 am, edited 1 time in total.

greg219
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Joined: Sat May 26, 2012 2:57 pm

Re: Risks buying intl denominated in non-home currency?

Post by greg219 » Tue Mar 24, 2015 11:24 pm

ogd wrote:This is correct. Only the underlying assets matter. The sale in USD and conversion to [some kind of] kroner would cancel out the currency volatility, assuming the conversion is done fast enough to make the volatility after sale negligible.


Thanks for confirming. I'm curious then how such a fund actually works in practice.

I believe a given stock is always denominated in a single currency. That means that all currencies represented by the stocks in the fund must've been owned by the fund at some point (otherwise, they wouldn't be able to buy the underlying stocks). But you as an individual only operate in a single currency (e.g., USD). So at what time does the fund do the currency conversions? When the individual buys/sells the fund or some other time? Do they batch it? Does the shape of the forex movements over time actually matter? For example, you buy the fund when 1 USD = 10 units of the basket of currencies in the fund; you sell 5 years later when 1 USD = 20 units; now, does it matter for the sell price of the fund if the 10->20 movement happened linearly over those 5 years vs if it all happened on the last day (i.e, 1 USD = 10 units for all days except the last day before you sold, when it jumped to 20 units)?

greg219
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Re: Risks buying intl denominated in non-home currency?

Post by greg219 » Tue Mar 24, 2015 11:25 pm

TedSwippet wrote:Cross-border pensions are tricky. [...]

This is great -- thanks for the pointers. I'll need to do some research on this.

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ogd
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Re: Risks buying intl denominated in non-home currency?

Post by ogd » Wed Mar 25, 2015 12:26 am

greg219 wrote:
ogd wrote:This is correct. Only the underlying assets matter. The sale in USD and conversion to [some kind of] kroner would cancel out the currency volatility, assuming the conversion is done fast enough to make the volatility after sale negligible.


Thanks for confirming. I'm curious then how such a fund actually works in practice.

I believe a given stock is always denominated in a single currency. That means that all currencies represented by the stocks in the fund must've been owned by the fund at some point (otherwise, they wouldn't be able to buy the underlying stocks). But you as an individual only operate in a single currency (e.g., USD). So at what time does the fund do the currency conversions? When the individual buys/sells the fund or some other time? Do they batch it? Does the shape of the forex movements over time actually matter? For example, you buy the fund when 1 USD = 10 units of the basket of currencies in the fund; you sell 5 years later when 1 USD = 20 units; now, does it matter for the sell price of the fund if the 10->20 movement happened linearly over those 5 years vs if it all happened on the last day (i.e, 1 USD = 10 units for all days except the last day before you sold, when it jumped to 20 units)?

I assume it's at the time they buy the stocks, and yes they would batch it, cancel out in/out going money, etc. Funds can be quite complex though and they might do some of this through derivatives to mitigate currency divergence even further (like they might use derivatives to "acquire" the underlying at a time actually buying it would be disadvantageous). And ETFs, where it's third parties creating baskets, work differently still.

Theoretically, either you or the fund can be caught on the wrong side of a sudden currency movement (if "it all happened on the last day"). I wouldn't worry about this being a big problem though -- speaking of those ETFs and the bad European markets, you are much more likely to lose money with every ETF purchase through the "inefficiencies" (from which someone profits, but it's not you) associated with ETF trading.

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