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Financial planning tips

December 12, 2016

How to manage foreign exchange risk

Find out how a drop in the Canadian dollar can affect your finances even more than an interest-rate hike – and what you can do to protect yourself.

Last January, my friend Bob was upset by the $8.49 cost of a head of cauliflower at his local supermarket.

Because it was winter in Canada, the cauliflower had come from California. Unfortunately, the U.S. dollar had shot up by 30% (in Canadian-dollar terms) in just 14 months!

Also last January, my wife and I were spending the winter in Italy. We had found a good deal on an apartment, but like Bob in Canada, we were shocked by the impact of the foreign exchange (FX or forex) rate. In the 9 months since we began planning our trip, the euro had risen by 21% against the loonie! As a result, we went over budget on our winter vacation, despite careful planning and budgeting.

It’s not just snowbirds who face the risk of changing FX rates, but you probably don’t hear a lot about the impact of recent big changes in FX rates. Instead, journalists and economic commentators seem transfixed by the possibility of an increase in interest rates.

But depending on your situation, a rising FX rate could have a much bigger, more immediate impact on your finances than an interest-rate hike, especially if you plan to travel or have little or no debt.

Changes to foreign exchange rates are notoriously unpredictable. Almost no one predicted the outcome of the Brexit vote and the subsequent steep decline in the British pound in Canadian-dollar terms. And few foresaw the sharp drop in the price of oil or that the loonie would also fall hard. Changes in FX rates can be dramatic and erratic.

So don’t even try to predict how FX rates will change; it doesn’t work. Since you can’t eliminate the risk, here are tips to help manage it.

Managing foreign exchange risk at home

  • Avoid buying big-ticket goods manufactured abroad or delay your purchases until the Canadian dollar has risen in value, if you can.
  • Buy local whenever possible, especially vegetables and fruits in season.
  • Do like your grandmother did and fill your freezer when food items are fresh and cheap.
  • If you expect to spend a lot of time in a foreign country (as we do, since both of our kids live in Britain and – on arrival – our first grandchild will be Scottish), consider holding a savings or investment account in the currency of that country.

Managing foreign exchange risk when planning a trip

  • It’s especially important that you buy travel medical insurance. Not only do you get protection from the cost of the health emergencies your policy covers, but you’re also protected from a sudden spike in FX rates that can make a healthcare bill abroad even higher – and you pay the insurance premium in Canadian dollars.
  • Shop around for a good FX rate. Most banks charge a service fee; ask your bank to waive it. FX rates in mall outlets can be expensive, but new online FX services (like Knightsbridge) are worth checking out.
  • Buy your foreign currency when rates are low, not just before you leave. It’s like the investing principle of dollar-cost averaging: You buy part of the foreign currency you’re going to need when you see the rate is low. Buy more when you see the rate is low again.
  • Install an FX app on your smartphone, or monitor an online FX rates web page. Most days, I follow the FX link at the bottom of my bank’s home page.
  • Even if you’ve visited the same travel destination before, don’t assume that the exchange rate hasn’t changed. A visit to the Bank of Canada 10-Year Currency Converter tool will show you how the currency has changed since your last visit.
  • When booking a cruise, tour, hotel or other service, pay the entire amount if the FX rate is low when you book, but pay only the deposit when the FX rate is high.
  • Be careful not to stock up on too much foreign currency, as government policy is subject to change. A couple of examples: The Bank of England is replacing its £5 paper bank notes with polymer notes and the old ones won’t be legal tender after May 5, 2017. The existing £10 and £20 notes are also scheduled for replacement in England and Scotland. In late 2016, India suddenly scrapped its 500- and 1,000-rupee bank notes, leaving many with worthless currency.

Managing foreign exchange risk while travelling

  • Use one of the many currency conversion phone apps to help you make smart purchase decisions on the go. Is that $15 USD scarf a good buy? Is that €10 appetizer worth it? Do you really want to spend £5 on a coffee?
  • If you find you’re going to have foreign currency left over at the end of your trip, consider donating your coins and bank notes to a charity (some airlines and airports make this easy) or topping up a stored-value card at a retailer (such as Starbucks) that lets you use it back in Canada.

As a next step, why not call your financial advisor and talk about how changing foreign exchange rates could put your goals at risk?

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