One of the important risk management method when it comes to investing is diversification. You can diversify between asset categories, industries, countries etc. When it comes to global diversification, you will definitely meet with one issue: the currency risk.
Currency risk can be a particularly hot topic if you are a non US based dividend growth investor.
There are some great, stable dividend paying companies all around the world, but in terms of choice, nothing can really compete with the US stock market.
Even though I live in the Netherlands, if you have a look at my portfolio, you will see that most of my holdings are US stocks. This most likely won’t change within the next few years. At the same time it also means that I’m affected by the EUR/USD exchange rate quite significantly.
Please have a look at the below chart:
The blue line represents the change in the S&P500 value since 1st March 2017 until 22nd September.
The red line represents the change in the S&P500 value since 1st March 2017 until 22nd September. In euro…
The starting date was of course chosen intentionally. That was the time when the index has hit its high in euro, and when the European currency has started to gain strength against the US dollar.
As you can see, during this roughly 6 months the S&P500 has gained nearly 5%, while there were times when its value in EUR has lost around 10%.
When to worry?
Shall I worry about the exchange rate? At the moment I don’t think I should. This is because of multiple reasons:
- The fact that I continuously invest also averages my cost in euro. With stronger euro I can buy more US stocks, while if later the USD gets stronger, my portfolio value and dividend income in euro will increase
- Even though I get less dividend in euro when the dollar is stronger, if I reinvest those dividends in US assets, the effect is basically neutral
- I am still in the wealth accumulation phase of my financial journey, so I should care more about building up a strong portfolio, rather than my day to day portfolio value in euro.
However, the exchange rate effect can be significant for me once I reach FIRE, and will rely on the income of my portfolio.
No matter if we are talking about dividend income, or withdrawing a certain amount from my portfolio on a yearly basis, if I have the majority of my assets in USD, a strong euro would mean less income to spend in Europe.
In the future, I definitely need to take care about this issue. This can be done in two ways:
1. Increasing my assets in EUR as the date of early retirement is approaching
Investing in Dutch real estate is definitely a part of this plan. The plan is that we will have at least 2-3 rental units by the time of early retirement, hopefully mostly paid. This would already mean quite significant assets in euro.
Also, getting closer to early retirement, the asset allocation should be more conservative. This means significantly higher portion of bonds in my portfolio. Most likely these will be euro denominated bonds (hopefully with higher yields than nowadays).
Yes, travel, more like long travel! If the euro is strong, there’s no good reason to spend my USD income in the euro zone. At the same time I wouldn’t mind spending some time in the US or in other countries whose currency is more liked to the dollar.
Yes, travelling in those cases can actually save money. Isn’t it real freedom? Right now it’s more like just day dreaming for me, but I’m quite convinced that those days will come too.
Readers, how do you deal with foreign currency impacts? I’m interested to hear from people in various countries.