How to manage your exchange rate risk

Last Updated on February 29, 2024

The information contained in this article is for general educational purposes and should never be viewed as specific investment, tax, or legal advice.

Currency rates are often on a lot of people’s minds here in Israel. For those of us with income and/or savings outside of Israel, there is real fear that the shekel could continue to strengthen in the future reducing the value of our savings abroad. American retirees in Israel dependent on low-risk retirement savings and social security income have been hit especially hard over the last couple of decades by very significant drops in exchange rates.

In this article I will explain what exchange rate risk is and illustrate some of the different approaches for dealing with it.

What is currency exchange rate risk

Exchange rate risk is is the risk that currency you own today will lose value relative to the currency you need in the future to pay your bills. This risk is especially prevalent in a situation where your cost of living is in a different currency than what you earn or save in.

Why it matters

Fluctuation in currency can have a very significant impact on your finances. Someone living in Israel while working for a US based company could very well be seeing their income go down in value at the same time their cost of living is going up. Fluctuations in exchange rates can make both short-term budgeting and long-term financial planning extremely difficult. To illustrate this further, the following story is an example of what impact exchange rates can have over time:

The year is 2002 and Leah, 50, has recently made Aliyah. Having just lived through the dot com market crash and 9/11 she is extremely fearful of investing and keeps most of her savings in cash. On a chilly morning in November she receives a call that an inheritance she was due a while ago has finally cleared probate procedures and that one million dollars will be transferred to her checking account. She considers transferring the funds to Israel and checks the exchange rate (4.7044) but decides it’s too complicated and she doesn’t need the money right now. Almost 20 years later (Nov 1, 2021) that money is still sitting in her checking account and the same amount of dollars that would have bought her 4.7 million shekel will now only buy her 3.1 million shekel – a loss of 1.6 million shekel!

This is obviously a pretty extreme example and most people don’t have a million dollars sitting around in a checking account for nearly 20 years – but you get the point. If you hold dollars, the strengthening of the shekel and weakening of the dollar can have a major impact. The chart below shows the dollar exchange rate against the shekel since Nov 2002 – the final drop doesn’t even fit on the chart. There have been ups and downs but the general trend has been down down down!

Dispelling common currency myths

Many people think that by investing using Israeli brokerages instead of US ones you eliminate your currency exchange risk. In fact, exchange rate risk is not about the currency denomination of your brokerage statements but rather about the underlying asset that you hold.

Let’s say I go into my US brokerage account and buy EWU, an IShares ETF which holds British stocks – which currency am I exposed to? You may have thought that since you bought the fund using USD your currency exposure is to USD. In reality, since the underlying assets held by the fund are far more dependent on the British pound – your primary currency exposure is to the pound. What about if I were to go into my Israeli brokerage and buy an Israeli ETF in shekels which tracks the S&P 500 that trades on the Tel Aviv Stock Exchange?

The truth is that even though I purchased the funds using shekels and my account value is displayed in shekels, the actual assets have very little exposure to the shekel. All other things equal, the actual return of buying an Israeli S&P 500 ETF via the Tel Aviv stock exchange and a Vanguard S&P 500 ETF via the New York stock exchange would be exactly the same regardless of the currency you purchased the fund in. (In practice, they aren’t actually equal because an Israeli ETF will have a higher expense ratio than Vanguard does.)

At the end of the day, investing in equity (stocks) or real estate is very different than investing in currencies or bonds. Regardless of which currency the price a stock or property is listed in, their value isn’t dependent on a specific currency. The price or return of any one asset measured in two separate currencies differ by an amount exactly equal to the exchange rate at the time of measuring. Most people find these concepts confusing and don’t really understand its implications. As you will see more below, it is imperative you have a basic understanding of these concepts before deciding the best way to manage your cross-border savings.

General approaches to handling currency exchange risk

It is almost impossible to eliminate exchange rate risk entirely, especially if you have income and/or savings abroad. Breaking down the different approaches to handling currency risk into two broad categories would look something like this:

1. Ignore it
2. Reduce it

These approaches are not mutually exclusive. You may apply one approach to one “bucket” and a totally different approach to another “bucket”. For example, you may choose to ignore exchange rate risk for long term investing while seeking to reduce or eliminate it for everyday spending. We will explore different strategies in each category and discuss how each approach may impact your finances in an uncertain future. All financial decisions have tradeoffs and there is no one-size-fits-all solution for managing currency risk.

Ignore it

Reasons to Ignore It

Not the main driver of long-term returns

Generally, having a good well diversified investment portfolio is far more important than what currency you are using to invest. Despite how it may feel, currencies like the dollar and shekel are relatively stable against one another and are unlikely to be the main driver of your long-term return. Take for example the story of Leah mentioned above – had she taken those dollars and instead of letting them sit in a checking account she invested them in a S&P 500 index fund – that one million would now be worth over 7.5 million USD (see chart below) – a gain of over 18.5 million ILS despite the massive drop in exchange rate. While the dollar has declined very substantially against the shekel, the US stock market certainly has not.

Limited Investing options in Shekels, especially for an American

Israel is a small country. The Israeli Market represents a tiny fraction of a percent of the worlds global equity and bond markets. In addition, Americans living in Israel are limited in the types of investments and accounts they can participate in because of the PFIC tax issue.

Bigger risks than exchange rate risk

There are many risks when investing and one of the main ways we address that is by diversifying our portfolio. Over emphasizing exchange rate risk and limiting investing options could be a costly mistake.

Currency rates could go in the other direction

Granted, over the last 20 years the shekel has strengthened fairly consistently against the USD and other major currencies and it may not feel like there is any end in sight to this trend. That being said, it could always go in the other direction and no one knows for sure where the shekel or dollar are headed in the future.

One of the main drivers of exchange rates overtime is generally thought to be the difference in interest rates between two countries. It is a possibility that due to higher-inflation in the US than in Israel, interest rates rise faster in the US than in Israel thereby significantly strengthening the dollar against the shekel. In addition, there are of course many other factors unique to the strength of the shekel that can’t be reliably forecasted.

This isn’t a prediction that I am or am not betting on. The point is that no one really knows where exchange rates are headed, not even the Central Bank of Israel and you shouldn’t believe all the articles out there all but guaranteeing that the current trend continues forever. The “experts” get financial forecasts completely wrong fairly consistently.

Strategies for Olim comfortable ignoring exchange rate risk

Long Term investing

Instead of limiting your options, invest globally and let your hard earned dollars or shekels be exposed to different currencies and companies all over the world. For step-by-step guidance and personal support, join our guided investment program.

Foreign CCs

American credit cards offer far better rewards and cashback than Israeli ones. By using your American no-foreign-transaction-fee credit card here in Israel you can take advantage of those rewards and avoid transferring money to Israel to pay for many of your expenses.

ATM cards

Many Olim with Schwab investment accounts like to take advantage of the fee free Schwab ATM card. This card allows you to withdraw cash in Israel in ILS from your Schwab dollar bank account at the live market rate. Keep in mind that If you withdraw the same amount of shekels each time you visit the ATM, a different dollar amount will be deducted each time based on the live market rate. If you don’t have a problem with Cash and regular ATM visits, this method can help you bypass other money transfer apps and services.

Find a job that pays more outside of Israel

The COVID pandemic accelerated the trend of remote work and digital nomads. Many companies are willing to hire workers who don’t reside near the corporate offices and some may even pay higher salaries than similar job opportunities here in Israel. Many people considering Aliyah are actively looking into the possibility of keeping their US based job after making Aliyah.

Keep in mind that there may be tax consequences for both you and the company hiring you in this situation. Make sure to speak with an Israeli accountant before accepting such a job offer. Obviously, you should also take note that the actual “value” (buying power in Israel) of your salary will fluctuate regularly based on the exchange rate. Here is a more detailed article on working for a US company while living in Israel.

Reduce it

Reasons to reduce it

By using an Israeli shekel bank account to pay your bills, the daily ups and downs of exchange rates won’t have an impact on your budget. Many people don’t want to see the price of their everyday goods constantly fluctuating. Taking steps in advance to reduce your exposure to the constant changes in exchange rates can improve your financial stability and increase your peace of mind.

Strategies for reducing exchange rate risk

Transfer funds for budgeted expenses in advance

By keeping the money you need to pay your upcoming bills readily accessible and in shekels you will dramatically reduce the stress sharp changes in exchange rates can bring. This method will also allow you to be patient and avoid converting funds when the market it most volatile and the rates are dropping sharply.

Keep emergency funds and short-term savings in Israel

Most financial planners recommend building up an “emergency fund” made up of cash or very low-risk investments before doing any long-term investing. The fund may include as little as 3-6 months worth of expenses or as much as a couple of years worth of expenses depending on your situation.

When living in Israel there is a good chance that any “emergency expense” you have will also be in shekels. Similarly, if you are saving up money for a down payment on a house or other big-ticket item, keeping those funds in shekels will significantly reduce your exchange rate risk. See our full article on short-term savings in Israel.

Dollar-cost averaging

With dollar-cost averaging, you exchange your currency in equal amounts, at regular intervals, regardless of the ups and downs in the market. By consistently exchanging the same amount of dollars to shekels every month, you will reduce your exchange rate risk without being overly fixated on the market swings. Obviously, the amount of shekels you receive will be different each month or interval.

Build a globally diversified portfolio

As mentioned above, building a globally diversified portfolio reduces your exchange rate risk because you will be exposed to many different countries and currencies not just the US dollar or the British Pound. Granted the Shekel has strengthened against most major currencies recently but that doesn’t mean it will continue that way forever.

Overweight Israeli stocks using US ETFs

In finance jargon, “overweighting” means allocating more capital towards a particular stock, sector, or country then is found in the benchmark or index. Since Israel represents a tiny fraction of a percentage of the global equity markets, putting even 1% of your portfolio into Israeli stocks would technically be overweighting Israel and overweighting the shekel. Examples (not recommendations) of US ETFs that focus on Israeli stocks are EIS, ISRA, ITEQ, and IZRL.

Keep in mind that that the Israeli stock market is highly concentrated and considered by many to more risky and less liquid than investing in major global economies such as the US. In addition, many public “Israeli” companies that trade on the TASE and dominate these ETFs are dually listed multinational corporations with most of their earnings all over the world in different currencies. Even if you were to shift all your investments to stocks listed on the TASE, you would be significantly increasing the overall risk of your portfolio without reducing your exchange rate risk as much as you might think.

I broke down this option in much more detail in the article “The truth about the Israeli stock market“

Keep parts of your portfolio invested in the TASE

By opening an Israeli brokerage account to purchase stocks and bonds directly on the Tel Aviv stock exchange your investments will be easier to access and protect from changes in the exchange rates. Some like to use an Israeli Brokerage to invest safer portions of their portfolio in assets such as government issued shekel bonds.

Besides the market risks associated with the TASE, the very high minimums and fees of Israeli brokerages have made these platforms inaccessible and unattractive to many investors that are just getting started.

Don’t forget to look at your Israeli pension and Keren Hishtalmut – you may already have a significant amount of money invested in Israeli stocks and bonds and that should definitely be factored in. If you are not an American citizen and don’t have to worry about PFICs, you will have access to additional tools.

Buy Israeli real estate

Many individuals who purchase a home or invest in real estate in Israel already have a large portion of their net worth directly tied to the Israeli economy and priced in shekels. If you are able to rent out this property, you may even be able to increase your shekel income. Besides the illiquid nature and concentrated risk of owning a single property, keep in mind that buying Israeli real estate may not be as good of an investment as many people assume – read more about this on “Remember the Fish“.

Use Israeli P2P lending platforms

Peer-to-peer lending platforms is an option to consider for Americans in Israel looking for a relatively stable shekel based investment vehicle that avoids the PFIC issue. Some popular Israeli peer-to-peer platforms include Blender, Tarya and BTB Israel.

Take note that during the last major financial crisis in 2008, peer to peer lending was still in its infancy. There isn’t much data available on how peer-to-peer loans would perform during a time of major economic distress or in the event of many users rushing to pull their money out at the same time. You should not transfer money to these platforms that you may need to withdraw quickly and you should make sure to understand the risks before investing.

Stay employed with an Israeli company

By working for an Israeli company you ensure that your salary and likely your biggest source of income is earned in the currency you need most.

Shift expenses

An obvious but often insignificant way of reducing currency risk is by shifting more of your cost of living to the currency you earn in. For example, if you earn in USD you can buy more of the things you need from sites that are priced in dollars and offer free international shipping such as Amazon and Iherb. Given the need to stay under $75 to avoid import taxes, this usually doesn’t have a major impact. That being said, ecommerce and free global shipping are growing trends and this could become a more significant opportunity in the future.

Using currency hedged ETFs

If you’re an American like me, most if not all Israeli ETFs are likely to be considered a PFIC and therefore probably not an option. If you aren’t, there are shekel hedged ETFs which can you give you exposure to major indexes like the S&P 500 while also protecting against the weakening of the dollar. Currency hedged products tend to have higher fees than standard index funds and reduce long-term returns but may provide less volatility in some situations.

Advanced financial instruments – using options, CFDs and forward contracts

Given that these instruments are not available or appropriate for most investors I am not going to go into too much detail here. There are ways to “buy insurance” for your portfolio against the weakening of a currency. High net-worth individuals who want to hedge their wealth against changes in exchange rates should discuss these tools with their financial advisor. If you want to learn more, here is a detailed article on the subject.

Best Practices

• Keep your exchange costs low – Whether you plan on making regular currency exchanges or occasionally transferring larger lump sums, keeping currency exchange costs low is an important part of any cross-border financial plan. For a detailed article on how to lower your exchange costs, click here.
• Invest and save in a way that you are comfortable with – Don’t let the exchange rate tail wag the investing dog. Pulling your money out of investments you feel comfortable with and moving them to platforms in Israel you don’t, is not a recipe for a successful long-term financial plan. Investing always involves risk and if you don’t feel comfortable with or have a basic understanding of your investments, you are more likely to bail when the going gets tough. Make sure any financial plan takes this into account and doesn’t just focus on what’s happening lately with the dollar or the markets. For more information on how to grow and maintain your international investments from Israel, click here.
• Have a plan and stick to it – Don’t let the headlines drive your decision making. Think about how you felt the last time the dollar dropped and make a plan that keeps that in mind. Taking some risk is a necessary part of building wealth but sleeping at night will always be more important than higher returns.