International diversification and exchange rate hedging during retirement??

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zzzz
Posts: 39
Joined: Wed Jan 16, 2008 8:29 am

International diversification and exchange rate hedging during retirement??

Post by zzzz »

Reposting from: viewtopic.php?f=1&t=324240&p=5502774#p5502774
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Hello everyone!

I'm looking at retiring in 2030, just over 10 years away. We plan to retire to our native Ireland - we're also US citizens - and will be looking at making a purchase of a home/apartment no sooner than 5 years from now (2025).

Our retirement funds are all in US Dollars in mutual funds with Vanguard and the federal Thrift Savings Plan that will be subjected to US taxes when we start drawing on them. In addition to the retirement funds my wife and I both have modest US government FERS pensions (fixed monthly payments) to draw on plus monthly US social security payments. These two forms of income are fixed/defined benefits and will (should?) not depend on the stock market.

One of our biggest risks is that our income will be in US Dollars, but we will be spending it in Euros and do not want to see our incomes drastically reduced due to exchange rate fluctuations while retired. How do we go about mitigating the exchange rate risk?

Approaches that I'm currently considering:
I'm considering moving some cash savings to Ireland in the 5 years before we move, in a fixed sum each month to smooth out the impact of fluctuations in exchange rates. These funds could also be used to generate income but are more likely to be used as a cash reserve stuck in a bank.

After retirement I'm considering moving, say, 1/2 of our retirement funds incrementally (a fixed sum each month) to Ireland or other Euozone country where it can be used to generate income in Euros and investing in this kind of Vanguard Eurozone Government Bond ETF: https://americas.vanguard.com/instituti ... tfoliodata .

In the interim I have some funds in Vanguard's Global Bonds ETF (BNDX) and in Vanguard's European Market ETF (VGK) both of which are undehedged from an exchange rate perspective. I think I should explore overweighting these investments in Europe from here out, and underweight the Pacific and EM components of my allocation (by selling some of my Pacific ETF, VPL and the EM ETF, VWO). Currently I'm overly weighted towards the Pacific region and EM, and am consequently am underweighted in Europe. Does this sounds like a decent strategy, especially given the relatively favourable exchange rates at the moment?

Many thanks in advance for suggestion and comments!
TedSwippet
Posts: 3167
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: International diversification and exchange rate hedging during retirement??

Post by TedSwippet »

zzzz wrote: Fri Sep 18, 2020 2:36 pm After retirement I'm considering moving, say, 1/2 of our retirement funds incrementally (a fixed sum each month) to Ireland or other Euozone country where it can be used to generate income in Euros and investing in this kind of Vanguard Eurozone Government Bond ETF: https://americas.vanguard.com/instituti ... tfoliodata .
Your post truncated the link to ETF data, but are you referring to this fund from your other thread?:

EUR Eurozone Government Bond UCITS ETF

If yes, as already noted elsewhere by occambogle, you'll want to avoid it. It is not US domiciled, and so will subject you to a pretty appalling US tax regime. More in this wiki page:

Passive foreign investment company - Bogleheads

In general, you need to continue investing as if US residents; that is, do not use any non-US domiciled mutual funds or ETFs. The following wiki pages offer an overview of how your tax situation will change (that is, become very complicated, I'm afraid) once you move back to Ireland as US citizens:

Taxation as a US person living abroad - Bogleheads
US tax pitfalls for a US person living abroad - Bogleheads

Finally, you'll want to study the US/Ireland tax treaty to understand fully how your income in retirement will be taxed.

Treaties often assign sole taxing rights on pensions to country of residence, but the US has a special clause in them that negates large chunks of tax treaties for US citizens. As a result, some of your pensions may be taxable to both the US and Ireland, though with a foreign tax credit to mitigate any double-tax. The outcome is usually that you get the lower of the two countries' allowances but pay the higher of the two countries' tax.

(From a quick glance, it looks like your 401k/IRA would taxable to both countries {article 1 para 4}, your SS payments taxable only to Ireland {article 18 para 1(b}, and your US govt pensions taxable only to the US {article 19 para 1(a)}. Could be wrong though; the US/UK treaty is the only one I'm at all conversant with. Either way, if you have a professional tax preparer, they may well be putting their kids through college on your tax prep fees. :-( )
Valuethinker
Posts: 41155
Joined: Fri May 11, 2007 11:07 am

Re: International diversification and exchange rate hedging during retirement??

Post by Valuethinker »

zzzz wrote: Fri Sep 18, 2020 2:36 pm Reposting from: viewtopic.php?f=1&t=324240&p=5502774#p5502774
-------------------------------------------------------------------------------------------------------------------------------------

Hello everyone!

I'm looking at retiring in 2030, just over 10 years away. We plan to retire to our native Ireland - we're also US citizens - and will be looking at making a purchase of a home/apartment no sooner than 5 years from now (2025).

Our retirement funds are all in US Dollars in mutual funds with Vanguard and the federal Thrift Savings Plan that will be subjected to US taxes when we start drawing on them. In addition to the retirement funds my wife and I both have modest US government FERS pensions (fixed monthly payments) to draw on plus monthly US social security payments. These two forms of income are fixed/defined benefits and will (should?) not depend on the stock market.

One of our biggest risks is that our income will be in US Dollars, but we will be spending it in Euros and do not want to see our incomes drastically reduced due to exchange rate fluctuations while retired. How do we go about mitigating the exchange rate risk?

Approaches that I'm currently considering:
I'm considering moving some cash savings to Ireland in the 5 years before we move, in a fixed sum each month to smooth out the impact of fluctuations in exchange rates. These funds could also be used to generate income but are more likely to be used as a cash reserve stuck in a bank.

After retirement I'm considering moving, say, 1/2 of our retirement funds incrementally (a fixed sum each month) to Ireland or other Euozone country where it can be used to generate income in Euros and investing in this kind of Vanguard Eurozone Government Bond ETF: https://americas.vanguard.com/instituti ... tfoliodata .

In the interim I have some funds in Vanguard's Global Bonds ETF (BNDX) and in Vanguard's European Market ETF (VGK) both of which are undehedged from an exchange rate perspective. I think I should explore overweighting these investments in Europe from here out, and underweight the Pacific and EM components of my allocation (by selling some of my Pacific ETF, VPL and the EM ETF, VWO). Currently I'm overly weighted towards the Pacific region and EM, and am consequently am underweighted in Europe. Does this sounds like a decent strategy, especially given the relatively favourable exchange rates at the moment?

Many thanks in advance for suggestion and comments!
PFIC rules basically restrict you to US domiciled funds.

If you find an EUR hedged bond fund you can buy that. If not an Eurozone bond fund *is* a hedge if it is not currency hedged back into USD (most will be). There might be an ETF you can find.

Italian govt bonds are c 40 to 45% of the index. Your credit risk will be the Italian govt. The fact that the bonds yield 2% more than the Getmsn ones tell you that right now the market thinks there is c 2% pa greater chance of an Italian default.

For me that would be too much risk.

I suggest investigating direct purchases of Irish govt bonds. Or deposit savings w Irish banks. Because of the economic impact on Ireland of a hard Brexit, Irish govt bond yields might rise, providing an attractive entry point.

European stocks provide only a limited currency hedge. I would suspect c 50% or lower. For example 60 to 70% of UK' FTSe 100 earnings come from outside GBP. A fall in sterling of 10% as after Brexit vote leads to a 6 to 7% rise in FTSE100 index.

I would not want to lose the diversification benefit of holding US and Asian stocks. Although European index has many high quality multinationals such as NESTLE Shell Siemens Airbus etc it also has a lot of banks and insurance companies which are doing poorly and it has very little big tech - primarily ASM Lithography (semiconductors) and SAP (enterprise accounting software).

Whilst I have my doubts about the valuation of Chinese internet companies like Alibaba and Tencent, Asian stocks to me seem reasonably valued w some world winning companies like Taiwan Semiconductor (one quarter of Taiwan indrx).

And the US index has more than 60% of the world's leading companies. No way around that.

A final currency hedge would be an Irish property particularly if rented out. A flat in a good part of Dublin or a commutable house.
k b
Posts: 125
Joined: Tue Oct 15, 2013 8:43 pm

Re: International diversification and exchange rate hedging during retirement??

Post by k b »

Find the European equivalent of the three-fund portfolio and start accumulating it over the next 5 years in such a way that at least 50% of your portfolio is in EUR-denominated stocks and bonds.

Buying property is another option (as mentioned above), but it requires upkeep until you actually move in. Look into REITs that could provide somewhat comparable exposure.
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