For investors navigating the complexities of global finance, understanding currency exposure is crucial. A common question arises for those who spend in both USD and EUR: how should this be reflected in their investment portfolio? A general rule of thumb suggests aligning your spending currency with your assets, ideally around 50%. However, for individuals with dual spending currencies, like USD and EUR, a naive approach might suggest a 25% allocation to each.
The importance of currency diversification becomes evident when considering significant currency fluctuations. Dramatic shifts can impact portfolio value, highlighting the need for strategic allocation. Referencing the Cederburg portfolio strategy, a 50% US and 50% International stock allocation (excluding bonds) is often cited for potentially higher returns, particularly during inflationary periods where bonds may underperform. However, with this approach, EUR exposure might be around 8% (given the Eurozone’s market share), while USD exposure would be substantial, including social security benefits often denominated in USD.
Consider a portfolio with a 70/30 stocks/US bonds split, where 65% of stocks are US-based. This scenario leads to a roughly 76% USD exposure and a mere 7% EUR exposure. For someone with significant EUR spending, this EUR allocation might be considered low. Shifting to a 50/50 split between US and International stocks within the 70/30 stocks/bonds framework improves the balance, resulting in approximately 65% USD exposure and 11% EUR exposure. Again, social security adds to the USD weight.
The challenge arises when considering scenarios where the EUR appreciates significantly against the USD. In an era of shifting global economics and potential geopolitical changes, predicting currency movements is increasingly difficult. For investors concerned about bolstering EUR exposure, several options exist. One approach involves incorporating EUR exposure within the fixed income allocation. Alternatively, ETFs like the iShares MSCI Eurozone ETF (EZU) can be utilized to increase Eurozone stock holdings. Unlike some international ETFs that include significant UK allocations (which don’t directly address EUR exposure), EZU focuses specifically on the Eurozone.
It’s important to remember that focusing solely on country allocation isn’t a perfect measure of currency exposure. International companies often have global revenues and may hedge currency risks back to their home currency. However, for investors seeking more direct EUR exposure, allocating a portion of the portfolio to Eurozone-specific assets can be beneficial.
One potential adjustment could involve allocating around 10% to an ETF like EZU, funded by reducing bond and international stock allocations by 5% each. This shift could result in a portfolio with approximately 60% USD exposure and 19% EUR exposure, with the remainder in other global currencies. This example portfolio would break down to roughly 35% US stock, 30% International stocks, 25% US bonds, and 10% Eurozone stocks.
Finding US-domiciled funds that offer exposure to EUR-denominated bonds can be challenging. Therefore, increasing Eurozone equity exposure through ETFs like EZU can be a practical alternative to balance currency exposure. Careful consideration of these factors allows investors to construct portfolios that are more resilient to currency fluctuations and better aligned with their spending needs in different currencies.
