Currency exchange risk is a potential decrease in purchasing power related to currency exchange fluctuations when income and expenses are in different currencies. It can apply to expat physicians conducting telemedicine into the United States, earning income in US dollars while paying bills in a foreign currency; or to expat physicians earning a salary in foreign currency but with loans or bills in US dollars in the United States.
An Example of Currency Risk Exchange
Consider a physician who is paid $200,000 yearly to work for a US-based telemedicine company and living in Italy. Here is the graph of Euro/USD (y-axis is how many dollars are needed to equal one euro) over the past 20 years:
Over the past 20 years, the Euro/Dollar has ranged between 0.85 – 1.58 – hence the purchasing power of the US salary ranges between €128,205 – €235,294 – an enormous range!
Here Are 4 Ways To Reduce Currency Exchange Risk
- Plan ahead, and have an approximate budget for each currency: Know how much of each currency you will need in the next 1-3 years, plan ahead for larger expenses, convert currency when rates are advantageous, and then build an appropriately-sized emergency fund for each currency (see below).
- Be aware of historical averages and patterns, and buy low: Prior results in financial markets never guarantee future outcomes. Currency exchange rates are impossible to accurately forecast for professionals, not to mention for the layperson. While the future is uncertain, you will know whether the current rate is historically advantageous. It is also worth noting patterns in your currency exchange of interest; significant rate changes for the Euro/USD in the past 20 years have been transient, only lasting 2-3 years before regression to a mean of around ~1.2. It’s unclear whether this pattern will persist but may inform the size of your emergency fund.
- Keep an emergency fund in each currency where you have significant expenses: The more assets or income relative to expenses you have in a particular currency, the lower your currency exchange risk for this currency. If you are earning US dollars and spending Euros, it may be worth having between your next 6 months – 2 years’ worth of expenses in Euros. You will also want to factor in large expenses such as a down payment for a home ahead of time, particularly when exchange rates are historically advantageous. This protects from a steep reduction in purchasing power if the dollar were to crash versus the Euro, which could derail the purchase of your home. The size of your emergency fund depends on your tolerance of risk. If you plan to move and work abroad, it is worth maintaining accounts in the US to pay loans and other bills to again lower currency exchange risk. An added benefit is that maintaining your accounts will also keep your credit rating active, as credit ratings tend to be national, rather than international entities.
- Shop around for the lowest exchange rates and lowest fees: It is *possible* that the banks in your new home may have slightly lower exchange rates or better fees than some of the online exchange services such as Transferwise or Currencyfair, but to have an account at a bank in your new home, you will likely need the equivalent of a social security number in your new home country. Transferwise or Currencyfair can be helpful for making the initial currency exchange with limited fees, to cover costs of the move or your initial deposit for a lease. Since you may not have an established credit history in your new home, your landlord will likely ask for a larger deposit than usual, so plan ahead by exchanging currency at a favorable rate ahead of time.
Once you have a foreign bank account, don’t forget to file the Foreign Bank Account Report (FBAR): You *must* file the Foreign Bank Account Report if the aggregate balance of all your foreign bank accounts exceed $10,000 at any point during the year. This is intended to prevent tax evasion, and the penalties are steep – $10,000 for a ‘non-willful’ violation.
The extremely investment-savvy adventurer can, to further reduce risk, purchase foreign exchange derivatives such as options and futures contracts, but these derivatives can be costly, and I mention them merely for the sake of completeness. For the vast majority of us, taking the above steps will sufficiently reduce (although not eliminate) currency exchange risk.
If you are earning an income in one currency and having expenditures in a different currency, you run the risk of currency exchange fluctuations leading to significant changes in purchasing power, which could be detrimental. Careful planning can reduce this risk.
Dr. Emeric Bojarski is a Child, Adolescent, and Adult Psychiatrist and founder of Equilibrium Behavioral Health, a tele-psychiatry private practice. He attended Harvard Medical School, completed residency at Yale-New Haven Hospital, and fellowship at Massachusetts General Hospital and Mclean Hospital.