Does it make sense to hedge more as you approach retirement?

[dingdong]

The conventional wisdom on the forum is to never hedge your equity funds (with typical reasons being... increased costs / long term decline in sterling / just focus on having global diversification instead).

However does it make sense to start hedging at least a proportion of your portfolio as you approach retirement to reduce the impact should the pound unexpectedly strengthen?

IWDG is a hedged world tracker fund with expenses at 0.30 which is not that much more than the likes of VWRL at 0.22? So you could hedge 30% as an insurance policy say without a huge increase in your overall portfolio costs.

I'm struggling to see why increasing hedging as you approach retirement wouldn't be the right approach to help de-risk, in the same way that people increase their proportion of bonds (and particularly so if you plan to stay heavy in equities). What am I missing there?

[JohnW]

Hedging is taking protection against losing, in exchange for which you give up some potential gain. You’re talking about currency hedging, and your conclusion is valid for some personality types and their situations. For the risk-tolerant multi-millionaire needing to withdraw 0.5% of their funds per year to live on, it’s not needed; for you and me it’s a great idea.
Opposing that, folk say that currency movements balance out over the long term and equities are long term investments. But if you’re going to ‘gamble’ in equities for a 15 year period you don’t also need to gamble on currency movements, or do they ‘balance out’ over 15 years? In 1975 US$ was worth 300 yen; the yen appreciated to 80Y/$ over the next 30 years, 300 a fading memory. Would the Japanese investors been happy with some currency hedging?
Currency movements add volatility to stock values, and you can reduce that volatility with currency hedging but get the same stock returns (if you believe that currency movements ‘balance out’ over time). That means an unhedged portfolio will have a lower risk-adjusted return than a hedged portfolio, while everyone is seeking an investment with the highest risk-adjusted returns. Of course, hedging cost reduce the return somewhat, but ‘that much’?
Without knowing the future of sterling wouldn’t it make sense to hedge half of your equities, reflecting your equipoise? Depends on how much of a risk taker you can be, and whether you think you know where sterling is going long term.
There might be some risk that currency hedging requires forced selling in a crashing market when you’re on the wrong side of the hedge. I’ve read it once, I don’t understand. it.

[dealtn]

What am I missing there?

Most people have a natural hedge.

If £ strengthens your overseas investment income falls (in £ terms) but that same strength in £ means the things you buy from overseas (usually indirectly via shop imports such as food and oil) effectively fall in (£) price.

So income down but expenditure down as an offset.

[Urbandreamer]

I was thinking about starting a thread about investment attitudes with respect to different asset classes.

It strikes me that this thread is a clear example of why we might need such a thread.

Back to the subject, I'm retiring in a week and am not hedging foreign currency exposure. My feeling is that the £ is on a downward trend, hence such actions would/might "cost" me.
Further, I keep as little in "cash" or bonds as possible, as I see most currencies doing the same. This is obviously slightly different to concerns about the strength of the £.
FWIW values are 2.2% cash 2.3% corporate bonds.

I also have 0.2% crypto, and it is some of the arguments made against it on the crypto board that has got me thinking about attitudes.
After all, equities have some volatility, hence arguments to reduce exposure to them when approaching retirement. So how much of an issue is volatility?
Clearly 0.2% is unlikely to make a huge difference, so why the pariah status? But discussions should be for another thread.

[scrumpyjack]

I do agree that long term the pound has always been on a trend of depreciating against other currencies so there is no way I would hedge against it rising! I think it is safer to have a good spread of international investments and leave currency concerns to the market. Hedging is very likely to be an expensive mistake and if one is that risk averse, it might be better just to buy an index linked annuity.

[Dod101]

I do agree that long term the pound has always been on a trend of depreciating against other currencies so there is no way I would hedge against it rising! I think it is safer to have a good spread of international investments and leave currency concerns to the market. Hedging is very likely to be an expensive mistake and if one is that risk averse, it might be better just to buy an index linked annuity.

I agree with that. I would never consider hedging unless I had a very specific need for funds such as house purchase at a given date. Otherwise just take it on the chin. You can only hedge so much for so long anyway. It unwinds eventually.

Dod

[swill453]

FWIW I retired 9 years ago, funded exclusively by investments in ISA, SIPP etc. with a cash buffer (another 5 years till I get my state pension).

I didn't change my asset mix one iota when I retired, have never hedged anything nor ever bought a bond.

No regrets (so far).

Scott.

[88V8]

I'm struggling to see why increasing hedging as you approach retirement wouldn't be the right approach to help de-risk, in the same way that people increase their proportion of bonds (and particularly so if you plan to stay heavy in equities). What am I missing there?

If you enjoy investing and money management as a hobby, you could add hedging to the list of things that one might get wrong

V8

[JohnW]

Interesting observations on currency hedging.
‘Natural hedging’. That sounds reasonable, but if I try to quantify it, a 10% fall in the value of my unhedged stocks because the £ appreciated 10% would unlikely be followed by a 10% fall in the consumer price index. However, it raises the important matter that to what extent you currency hedge foreign stocks has something to do with how big a part of your portfolio they are.
‘The pound is headed down’. I’m not confident about that.
‘The pound has gone down and will continue to’. Anyone’s guess is no less valid than anyone else’s.
‘I wouldn’t currency hedge stocks unless I needed to cash out on a specific date’. I wouldn’t be in stocks anyway, hedged or not. That’s a job for a savings account.
‘I’ve never hedged anything, but have a cash buffer’. That’s a hedge against stocks going bad, surely?
‘You might get it wrong by hedging’. Or you might get it right.

[Wuffle]

The extraordinary decision in risk terms is the retirement.
It is totally emotional and no amount of intellectual naval gazing about hedging anything can make up for that.

The obvious clue is that poor people in 3rd world countries don't.
If Apple decided next week to wind down all the profit centres and in the small print talked about hedging.......

W.

[Urbandreamer]

The extraordinary decision in risk terms is the retirement.
It is totally emotional and no amount of intellectual naval gazing about hedging anything can make up for that.

The obvious clue is that poor people in 3rd world countries don't.
W.

People in this country didn't use to either. It's amazing the number of people who quote Mr Micawber.

'Annual income 20 pounds, annual expenditure 19 [pounds] 19 [shillings] and six [pence], result happiness. Annual income 20 pounds, annual expenditure 20 pounds ought and six, result misery. '

Without remembering that he died in the workhouse.

Anyone who does want a comfortable "retirement" does have to indulge is serious financial planning, from fairly early on in life.

Of course some would argue that the state pension was introduced to avoid such misery with a "cradle to grave" promise......

I'd recommend that putting some effort in rather than relying on being looked after or the ability to continue working, might just be a good idea.

[Dod101]

Interesting observations on currency hedging.
‘Natural hedging’. That sounds reasonable, but if I try to quantify it, a 10% fall in the value of my unhedged stocks because the £ appreciated 10% would unlikely be followed by a 10% fall in the consumer price index. However, it raises the important matter that to what extent you currency hedge foreign stocks has something to do with how big a part of your portfolio they are.
‘The pound is headed down’. I’m not confident about that.
‘The pound has gone down and will continue to’. Anyone’s guess is no less valid than anyone else’s.
‘I wouldn’t currency hedge stocks unless I needed to cash out on a specific date’. I wouldn’t be in stocks anyway, hedged or not. That’s a job for a savings account.
‘I’ve never hedged anything, but have a cash buffer’. That’s a hedge against stocks going bad, surely?
‘You might get it wrong by hedging’. Or you might get it right.

The trouble with these forums is that unlike chatting to someone you cannot add stuff like 'Yes but I did not quite mean that' and amplify your statement, but on the whole I agree with your post.

Dod

[scrumpyjack]

Yes, and the reference to annual expenditure of £20 is a sobering reminder of what inflation has been suffered in this country!

[JohnW]

And here’s why you might not hedge currency movements: Some currencies appreciate when stock markets are buoyant, and fall during economic downturns, such as ‘commodity currencies’ like $Australian and $Canadian. Conversely, some currencies are a ‘flight to safety’ and appreciate in ‘bad times’, such as $US and Euro. Such ‘reserve’ currencies recognise, and demand, the strength and stability of their financial systems, and so are not fixed; $US displaced £ last century, and the Yuan might displace $US.
So, a US investor in global equities might want foreign currency hedging for protection against foreign currency depreciation in bad times, but a UK investor might not want hedging so as to take advantage of reserve foreign currencies appreciating against £ in bad times. https://rationalreminder.ca/podcast/250 Start listening at 1 hour and 1 minute.

[GoSeigen]

Yes, and the reference to annual expenditure of £20 is a sobering reminder of what inflation has been suffered in this country!

And what do you think is the problem in our country that means we have had inflation but other comparable countries haven't?

Rhetorical question -- everyone here sober or otherwise knows that inflation is not a "this country" thing.


GS

[scrumpyjack]

Yes, and the reference to annual expenditure of £20 is a sobering reminder of what inflation has been suffered in this country!

And what do you think is the problem in our country that means we have had inflation but other comparable countries haven't?

Rhetorical question -- everyone here sober or otherwise knows that inflation is not a "this country" thing.


GS

When I first went skiing there were over 12 Sw francs to the pound. It is now less than one tenth of that. So sure other countries have had periods of rapid inflation (eg France and Germany) but we have have a long long record of debasing our currency

ps my uncle could remember it before WW1 and I think he said it was 23 to the pound then!

[Lootman]

When I first went skiing there were over 12 Sw francs to the pound. It is now less than one tenth of that. So sure other countries have had periods of rapid inflation (eg France and Germany) but we have have a long long record of debasing our currency

ps my uncle could remember it before WW1 and I think he said it was 23 to the pound then!

In the 1990s or so there was a slew of offshore funds that would borrow in low-rate currencies like CHF and JPY, and then invest the money in high-rate instruments like Danish mortgages and Italian bonds.

Needless to say, that worked great until it didn't.

[Urbandreamer]

And what do you think is the problem in our country that means we have had inflation but other comparable countries haven't?

Rhetorical question -- everyone here sober or otherwise knows that inflation is not a "this country" thing.


GS

When I first went skiing there were over 12 Sw francs to the pound. It is now less than one tenth of that. So sure other countries have had periods of rapid inflation (eg France and Germany) but we have have a long long record of debasing our currency

ps my uncle could remember it before WW1 and I think he said it was 23 to the pound then!

I wrote a quite long response to GS, then deleted it. Let us be honest you don't have to be drunk to know that Turkey has suffered from high inflation due to government policies. You just have to actually pay attention to financial news.
Likewise you may be aware that Japan has had 30 years of very low inflation, and some deflation.

Comparable countries? Is this a way of saying that similar policies have similar effects? I would think that would be obvious. In the end I decided that it was unlikely that GS was totally unaware of any of these facts and that he might have a reason to suggest we have been drinking something other than coolaid. Which is why I decided that it wasn't worth pointing these facts out to him.

[scrumpyjack]

When I first went skiing there were over 12 Sw francs to the pound. It is now less than one tenth of that. So sure other countries have had periods of rapid inflation (eg France and Germany) but we have have a long long record of debasing our currency

ps my uncle could remember it before WW1 and I think he said it was 23 to the pound then!

I wrote a quite long response to GS, then deleted it. Let us be honest you don't have to be drunk to know that Turkey has suffered from high inflation due to government policies. You just have to actually pay attention to financial news.
Likewise you may be aware that Japan has had 30 years of very low inflation, and some deflation.

Comparable countries? Is this a way of saying that similar policies have similar effects? I would think that would be obvious. In the end I decided that it was unlikely that GS was totally unaware of any of these facts and that he might have a reason to suggest we have been drinking something other than coolaid. Which is why I decided that it wasn't worth pointing these facts out to him.

Yes, I'm sure you are correct. But some countries manage to be successful economically without significant long term inflation, and indeed the absence of inflation is probably a major factor contributing to their success. Unfortunately the UK isn't one of them. We are like the drunk who keeps having another drink, because it avoids the temporary pain of the hangover!

[vand]

Unclear if OP is talking about actually hedging against a broad fall in stock prices, or currency hedging.

No to both imo.

If you buy global stocks you want then unhedged to protect against loss of purchasing power in your local currency.

If you want a less volatile portfolio then diversify with other asset classes rather than with, say, protective puts.