How currency can influence your pension
Many UK expats hold pension assets in pound sterling that plan to retire in the US. This creates a currency challenge as conversion to USD will likely happen at some point.
Historically, the pound has enjoyed a stronger exchange rate and some can even remember when one pound bought two dollars. Now, with such attractive conversions a distant memory, we speak daily with concerned clients on the best way to manage this situation.
Many factors have weakened sterling, not least the uncertainty surrounding Brexit.
Trying to predict currency movements can be one of the easiest ways to lose money, particularly when we throw in the human element that the political circus adds. The sheer number of influences on a currency pair and the nuanced way they interact make it a minefield for even the most experienced of currency experts.
A key advantage of an international pension such as a ROPS (formerly QROPS) or a specifically designed SIPP, is that you have the ability to convert GBP to USD at any time, therefore giving you the flexibility to convert at a time of your choosing.
So when should you convert?
The important caveat is that every individual has different circumstances so there is no ‘one size fits all’ approach. However, there are some practical considerations.
Market timing – predicting where the currency pair is going. This can be extremely difficult and the chances of getting it right may be more down to luck rather than skill. Many clients can find themselves falling into this category without truly realizing.
Often a client will pick an exchange rate that they consider to be fair value, for example 1.5. They will then take the position that they are going to hold out until the rate gets back to 1.5 before converting their fund. It is not to say that this will never happen but anyone taking this stance should be aware of the risks involved (after all, this is a long position at a time when the traders in the market are taking a short position).
Factoring matters such as Brexit into this equation means trying to predict how it will play out and whether it is more or less favorable for the pound. So, there is risk here as it is very difficult to predict which way it will go. So before embarking on such a strategy, ask yourself, can I tolerate the risk that I’m wrong?
Dollar cost averaging
Your pension funds do not need to be converted all on the same day. Dollar cost averaging is a timeless strategy for investing in capital markets by removing the element of market timing. For example, a person that has 10 years until retirement could choose to convert a portion of their pot each year up to retirement so that the whole fund has been converted before their first day of retirement. In doing so, the client will get a different exchange rate for each conversion and therefore, rather than getting the best or the worst rate, they will simply get the average. This more risk averse approach does not require you to make a prediction on the direction the currency pair will move.
Convert it all in a day
Some clients have the opinion that the pound will not weaken further and recover. However, we do still have clients that have a desire to convert their whole fund from pounds to dollars as soon as possible.
Like market timing, it does come with the same risk that the rate moves against you. Here though, the losses would be in the form of the opportunity cost for not waiting.
Unlike the risk tolerant market timers, those that convert presently are often doing so for certainty and peace of mind and are less concerned with the rate they are getting and more motivated to remove the potential stress and energy required to keep considering foreign exchange for years to come. Once the funds are all in the currency that you will be spending in retirement, it removes an important variable making it easier to plan.
In summary, foreign exchange can be a minefield and predicting where the pound might be is far less valuable than understanding the strategies that you can implement, the risks associated and how you can manage those risks. Your Brite Advisor can help guide you through complex currency markets.