When investing your hard earned saving there are really two ways to go about it. You can have individual holdings in an account, or a “package” of holdings in the form of a mutual fund for example. The “packaged” route is common as many investors are wary (with good reason) of selecting their own individual choices. In addition, it is possible to have individual security selection made on a discretionary basis by a manager; the idea being to create a more personalized or customized solution for you.
You may wonder what the heck that has to do with currency risk. Well, the thing is that with a packaged solution like a mutual fund, especially one that is meant to be “widely diversified” is that they often have just enough foreign exposure to have the potential for your return to be eroded(or enhanced) by an adverse move in currencies.
When it comes to someone who is investing for income and is therefore interested in as much of a consistent return as possible- that is when a minor annoyance can become a big problem. Why? Well it has to do with the little discussed problem that the risk from a foreign currency is going to make a lot of difference to someone who is only expecting a 4% or 5% return on their investment. It is one thing for a young person who is invested in a racy portfolio and trying to get a 15%+ return-that person might relish the additional risk from the currencies. They might want to gamble that they will swing in their favour.
Understood, let the young folks gamble away if that is their wish but before an older person buys a mutual fund with a foreign component I would advise a conversation with their advisor about currency risk. I mean hey…if 20% of a portfolio has a 20% swing down due to currencies is will cause a 4% loss in the fund. If the fund only returned 5% then you don’t need to be a mathematician to understand that taking that risk in the first place might be questionable. Learn to question the questionable I always say.
I explain more about currency risk and other common pitfalls in my acclaimed book: InSync Income, The Must Read Guide to Investing for Income in Canada. Chapter 1 is a must read for anyone in retirement or near retirement.
I generally do not believe that foreign investments are a good way to go for income seeking investors and generally recommend excluding foreign investments in an income generating portfolio. That being true there are ways to hedge foreign currency risk that are utilized by some money managers that could be useful under some circumstances. A situation where this would be true would be where there is an opportunity to pick up significant additional yield from a foreign investment-a much higher interest rate for example, and the currency could be hedged at a low cost. It is possible to add value in that way.
It might pay well to consider using a money manager to build a more customized portfolio for you. You could then better control currency risk and have more flexibility- to decide to exclude certain sectors for example. I think it is a route worth exploring. Virtually all the major investment houses, like ScotiaMcleod for example, offer managed account programs that are more customizable in this way.
It certainly pays to have professional advice in any case. My recommendation it to seek out an appropriate financial professional prior to implementing any new financial strategy or change any existing strategy. Invest with advice for best results.
The Income Investor’s Advocate