"An investment in knowledge pays the best interest." - Benjamin Franklin
As an American investing while living abroad, one of your first considerations should be how to structure your investment portfolio.
Of course, how to do this depends on a variety of personal factors - your aspirations, time horizon, risk appetite or aversion, personal investment preferences, and your situation in life as well as future plans.
So rather than tell you how to structure your portfolio, we’re going to look at the different factors that you should take into consideration when structuring your investments as an American living overseas.
In this article, you’ll learn about:
• Investment goals and time horizon
• Risk tolerance
• Types of investments
• Whether to invest in the US or abroad
Investment goals and time horizon
The first question you should consider when deciding how to structure your investments as an expat is: what are your investment goals?
Investment goals typically vary depending on your age, also known as time horizon, meaning how long it is until you’ll want to draw from your investments. This is because assets that drive growth are often different to those that provide income. So if you don’t need to draw on your investments for a while, you are more likely to focus on growth-generating equities, whereas for a shorter time horizon, bonds may be preferable.
Time Horizon Examples - A young person in their twenties with some excess income decides to prioritize saving to buy a home, and also starting to save for retirement. The first priority could benefit from buying bonds, providing fixed income to grow the portfolio with little risk of loss, while for the long term, equities that will grow over decades despite some ups and downs could be appropriate. Someone in their fifties on the other hand, whose retirement income has been growing for a while, but who wants to generate some income in the short term for their kids’ college fees, may transfer some of their long-term investments into bonds.
You should always seek to discuss your goals with your financial advisor based on your personal priorities and plans.
Another factor relating to your time horizon is geographical: where will you expect to be when you start drawing your investments? This could impact your investment structuring too, as you may want to employ a natural currency hedging strategy.
Another factor that affects how you structure your investments is your risk tolerance.
Higher risk assets can generate higher portfolio growth, however they may also be more volatile, and so they can result in losses that, in some cases, can take years to recover.
If you’re in it for the long haul then it may not matter, because over decades you’re still likely to experience higher growth, based on long-term trends. But if you may need to draw on your assets in the short term, then it makes sense to be more cautious in terms of the assets that you invest in.
Your risk tolerance may be influenced by your investment goals, too.
Personality is another factor that determines your risk tolerance, as some people are naturally more aggressive or conservative in terms of their desire to take on riskier investments for a potentially higher reward.
Types of investments
When deciding on the structure of your portfolio, there are numerous different types of investment options available. Some of these investment classes and their typical characteristics are summarized below. The first step is deciding your asset mix, based on your investment goals, time horizon, and risk tolerance. Then, you’ll have to decide which assets within each class to invest in. This is where financial advisors can be incredibly helpful, as they have a detailed knowledge of current investment opportunities.
Also known as equities, stocks are issued by companies to raise cash in exchange for a share in the company that will hopefully grow as the company grows. Some companies also distribute their profits to shareholders in the form of annual dividends. Larger, longer-established companies are generally considered safer long-term investments. Small companies and startups are considered riskier, as they might take off and achieve sky-high growth, but conversely they might fail.
Bonds are issued by governments, states, and some companies as a sort of loan in exchange for a fixed annual payment or for a predefined payment when the bond expires after a fixed term. Bonds can be traded for a profit (or a loss) before they mature (expire), depending on how well the issuer is performing. As bonds feature a fixed income component and are debt instruments as opposed to equity, bonds are typically considered safer investments than stocks.
Mutual funds are professionally-managed funds that pool many investors’ money to purchase different stocks and other assets.
However, Americans living abroad should only normally invest in US-registered mutual funds, as the US has stringent tax and reporting requirements relating to foreign mutual funds, which the IRS classifies as Passive Foreign Investment Companies (PFICS).
Exchange-traded funds (ETFs)
ETFs are similar to mutual funds, but they often track a market or index. Again, US expats should treat foreign-registered ETFs with extreme caution, as the IRS also classifies them as PFICs.
Real estate investments, and real estate investment trusts (REITs)
There are many ways to invest in real estate, from owning rental property to investing in commercial or other real estate funds or real estate investment trusts (REITs).
Rental property can be a good investment option if you are looking for income, however rental properties come with the burden of management and maintenance.
Intellectual property, such as copyrights, patents, trademarks and royalties
This is a specialist investment area, though it can result in high growth, if you invest in a patent or copyright of something before it conquers the mass market. There has been a trend in recent years for investors to buy musicians’ back catalogs too, while buying the rights to make a movie from a book has held a large amount of appeal for decades.
Cash equivalents, such as certificates of deposit (CDs) or savings accounts
The safest investment is to keep your money in cash, such as in a bank, however while relatively risk-free, your money is actually losing value while it’s not working for you, due to inflation, and especially when inflation rates are high. Nonetheless, many investment advisors keep some funds in cash ready to invest if a new opportunity arises.
At the other end of the risk scale, investing in crypto is popular but very high risk, as crypto values fluctuate wildly.
Gold, other precious metals, art, and other physical assets
Gold and precious metals are considered safe investments at times when stock markets are experiencing sustained losses. Art and other assets, such as vintage clothes, cars or jewelry for example, can increase in value, however it’s wise to seek specialist advice when investing in these types of assets.
Diversification is a way of managing risk by spreading your investments around different asset classes to reduce your exposure to turbulence or loss in any single asset class.
A typical diversified investment portfolio includes a mix of stocks, bonds, and some cash held in case you suddenly need to access some funds or if you find a great new investment opportunity. The mix between stocks and bonds is traditionally seen as the higher the risk tolerance, the higher the proportion of stocks compared to bonds, and vice versa.
Whether to invest in the US or abroad
When deciding whether to invest in the US or abroad it’s important to understand the long-term tax and reporting implications in both countries, as well as taking into account your personal circumstances and future plans.
So, for example, if you are saving for retirement and you’re going to retire abroad, and the country where you live doesn’t have a tax treaty with the US that recognizes that distributions made from Roth retirement plans shouldn’t be taxed, it may make more sense to invest in a local rather than US retirement plan.
Furthermore, if you are going to draw income from investments held in another country in the future, you will pay for currency exchanges at that time, whereas if you invest in the US now while living abroad you will pay currency exchange costs now.
Another consideration is fees. As a US expat, if you invest in the US, your investment fees will normally be lower. You can still invest in foreign assets through a US broker, but you will pay less to do so.
So there are many factors to take into account what types of investments your portfolio will contain: your personal circumstances such as where you live now and where you intend to live and receive income from your investments in the future, investment fees, taxes, tax treaties, and tax reporting, and currency conversion costs. Your expat financial advisor will guide you through your options based on all these considerations.
We hope we’ve provided an overview of the main considerations when structuring your portfolio as an American living abroad.
Armed with this knowledge, schedule a call with your expat financial advisor to discuss how you might build and maintain your portfolio and achieve your goals now that you’re living abroad.
If you have any questions, don't hesitate to contact us.
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