If you live abroad, exchange rates can have a significant effect on your finances, even if you rarely give them much thought.
Your assets, income, and expenses may all be in different currencies, which can lead to uncertainty over your exact financial standing.
While this is typically not a problem in the short term, over the long term, it can have a considerable impact on your finances.
*While we use pounds and euros in some of the examples below, the same principles apply wherever your finances span different currencies, whether that includes US dollars, Canadian dollars, or others.
Read on to discover some of the ways exchange rates could affect your financial plan and the steps you could take to manage the associated risks.
Exchange rates could affect your retirement income
Changes in currency values can be particularly important in retirement because you may rely on income from one country to fund expenses in another.
For example, imagine you receive £30,000 a year from UK pensions but live in Spain.
If £1 bought €1.20, your £30,000 would be worth €36,000. However, if the pound weakened and £1 subsequently bought €1.10, the same pension income would be worth €33,000.
Your pension would still be paying exactly the same amount in pounds, but you would have €3,000 less to spend over the year.
Of course, currency movements can work in your favour too. If the pound strengthened against the euro, the value of your pension income in euros would increase.
This can also affect your personal pension, your State Pension, and other forms of retirement income you may have, such as ISAs.
So, it’s important to have a plan for managing currency fluctuations when planning your retirement income and expenditure.
Currency movements can affect your investments and property
Exchange rates can also influence property and investments you hold overseas.
Imagine an investment rises by 5% in its local currency. If that currency weakens against the currency in which you ultimately spend your money, some or all of your investment return could be lost when you convert it.
Again, the opposite could happen, which could work in your favour, but it’s important to have a plan that helps ensure your long-term stability.
Moreover, if you have moved overseas but still have a UK property, you might receive rental income in pounds while paying most of your living costs in euros.
As with pension income, the amount you can spend abroad will therefore partly depend on the exchange rate when you convert that rental income.
Changes in currency can become even more significant if you eventually sell the property and transfer the proceeds abroad.
For example, if you sell a UK property and have £500,000 to transfer to euros. At an exchange rate of £1 to €1.20, you would receive €600,000 before fees. At £1 to €1.15, you would receive €575,000.
So, just a small difference could mean €25,000 less, despite the pound value of your property proceeds remaining exactly the same.
Similar risks could arise when transferring a large pension lump sum, inheritance, business proceeds, or other significant amount of money between countries.
Taxes and inflation can add to the challenges posed by exchange rates
Currency movements can also influence areas of your finances you might not immediately associate with exchange rates.
For instance, if you’re a Spanish tax resident, you may need to report certain foreign income, gains, or assets in euros. Depending on your circumstances and the rules, the exchange rate used can affect the figures and potentially the calculation of the taxable gain.
You could also experience the combined effects of inflation and currency movements.
For example, if prices rise in Spain at the same time as the pound weakens, your living costs could increase while the euro value of your UK income falls, which could significantly reduce your spending power.
4 ways to manage currency risk as an expat
There isn’t a single approach to managing currency risk that’s suitable for everybody. Your strategy will depend on factors such as where you intend to live, the currencies you spend money in, the assets and income you have in different countries, and your long-term plans.
However, the following approaches may be worth considering.
1. Have cash savings in more than one currency
If you regularly spend money in both the UK and Europe, holding both pound and euro cash reserves could be useful.
That way, if the pound falls, you have the flexibility to draw from your existing euro reserves rather than immediately exchanging money at an unfavourable rate.
The size of your cash buffer will depend on your circumstances and should be balanced against the potential effects of inflation on cash.
2. Consider making transfers gradually
If you need to convert a substantial amount of money but don’t need all of it immediately, making a series of smaller transfers could reduce your exposure to the exchange rate on a single day.
This approach won’t necessarily produce a better overall exchange rate. Indeed, you could miss out if the exchange rate becomes particularly favourable shortly after your first transfer.
However, spreading conversions over time can reduce the risk of committing the entire sum at one particularly unfavourable rate.
3. Perform regular reviews
While exchange rates change daily, they can also follow longer-term trends, meaning the value of your money in another currency may shift significantly over time.
As such, it’s important to perform regular reviews to assess your exposure to currency changes and ensure that the way you hold your income, savings, and investments continues to reflect where you live and how you expect to spend your money.
4. Work with a cross-border financial planner with international expertise
Working with a cross-border financial planner can help you manage the challenges posed by changing exchange rates.
They can recommend strategies for managing risk tailored to your situation and the currencies you are exchanging between. Additionally, they can help you perform regular reviews to ensure your wealth and finances remain stable as you transfer them from one region to another.
To speak to a financial planner, get in touch.
Email contact@ambient-wm.com or call us on +34 658 077 450.
Please note
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.