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Portfolio Management While Living Abroad

May 8, 2023
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What special considerations apply to building an investment portfolio while living abroad?

Fundamental principles of portfolio management apply equally no matter where in the world the investor lives; however, asset allocation changes. Local currency and economic conditions need to be factored into the investment portfolio to get the right mix of exposures. Currency and global diversification being the most salient factors. To be successful in the long run, investors need to focus on four issues when making investment choices:

1. Currency and geographic diversification

Currency management strategy is a complement to, but not a substitute for, proper investment portfolio diversification. All investors, wherever they live, need to invest in a broad array of assets, including U.S. stocks, international stocks, bonds, emerging markets, and real estate. Proper diversification can substantially mitigate losses incurred during a severe market downturn.

This, in turn, helps sustain portfolio stability, and reduces the risk that the investor will sell out near a market bottom as a result of either need or emotion. Decades of academic research and real-world investor outcomes confirm that di- versification is the only way to maximize returns for a given level of risk.

2. Risk

Within a broadly diversified portfolio, the relative weight of higher return/higher risk investments (stocks) versus lower risk/lower return investments (bonds) needs to match the risk profile of the investor. Generally, as retirement approaches, investors should reduce exposure to a large market downturn by steadily increasing the weight of bonds in their portfolio. Many other factors— job security, near-term spending plans, or expected college expenses for example—also impact this calculation. Factoring in the right amount of risk is critical to providing the re- turns necessary to meet planning goals with- out being overwhelmed by the impact of market volatility.

3. Expenses

The ability of professional stock pickers and strategists to “beat the market” has repeatedly been shown to be exceedingly rare. A QAIB report of mutual fund investor returns during the period 1990-2019 found that the average equity fund underperformed the S&P 500 stock index by 4.92% per annum. A report from the 2021 S&P Dow Jones Indices found that 90% of all domestic funds underperformed the S&P Composite 1500 based on absolute returns in the past 20 years; when considering on risk-adjusted basis, the statistic rises to 95%.

The biggest reason for this dismal record lies in the high fees charged by fund management companies and brokerage firms. With long-run, annual stock market returns averaging around 9.96%, sacrificing 4.92% of an investment to annual fees and expenses will reduce the total return on an investment by 75% over 30 years. Over a half century the investment return will be reduced by 90%. Therefore, investors must pay close attention to the cost of investing their money.

4. Tax Management

A less obvious but still very serious impediment to long-term investment success is poor investment tax management. Portfolios with high turnover not only incur high commission and trading expenses, but also trigger taxation of capital gains earlier and at higher rates. A stable, low turnover portfolio that defers taxation and benefits from the low long-term capital gains rate will generate dramatically better after-tax returns than a fund that performs equally well on a pre-tax basis, but which has high turnover.

Use modern investment tools such as exchange traded funds to build a stable, diversified portfolio with the right amount of risk; manage investments to maximize returns on an after-tax, after-fee basis

These recommendations are especially relevant to Americans abroad because of the unfortunate tendency of many expats to change investment strategies as frequently as they change countries and to pay unnecessarily high investment fees (which are often hidden in complex derivative structures and non-transparent investment funds).

These mistakes are easily avoidable. Modern in- vestment instruments such as index mutual funds and exchange traded funds give investors all the tools needed to build a globally diversified portfolio of assets. No matter where they live, American investors working on their own or with the assistance of an advisor can (with some exceptions) open an account at one of the large U.S. discount brokerage firms and successfully employ these principles to build a winning long-term investment portfolio.

Continue to Retirement Planning for Americans Abroad

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This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.


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