All investments come with a certain degree of risk, and for Americans living in Spain, there’s the added challenge of navigating both US and Spanish investment rules and tax codes as well as Dollar/Euro exchange rates.
By understanding both your comfort level with risk and how much risk it is necessary for you to take to achieve your financial goals, you can minimize your exposure to investment risk, ensuring a better and more secure financial outcome. In this article, we’ll outline some of the considerations and factors that will help you make informed investment decisions tailored to your specific circumstances and risk tolerance levels as an American expat living in Spain.
In this article, we’ll cover:
- Risk tolerance
- What is risk capacity?
- Required risk
- Types of investment risks for expats in Spain
- Evaluating investment risk
- Mitigating investment risk
Risk tolerance
Risk tolerance refers to the level of risk you are comfortable with while pursuing your investment objectives. Several factors influence your risk tolerance:
- Your age: Typically, younger individuals are more inclined to take risks, as they have more time to recover from potential losses compared to those closer to needing to draw on their investments..
- Your personality: Your innate risk-taking tendencies play a role. Adventurous individuals may embrace higher volatility and risk levels, while more cautious personalities might prefer greater stability in their investments in general.
- Your investment goals: Your financial goals should be a major factor influencing your risk tolerance. For instance, someone with a long-term goal like retirement saving may be inclined to accept higher risks in pursuit of greater long term returns, while someone with an imminent need, such as funding their child’s college education, might prefer a more conservative approach.
Investment advisors typically categorize risk tolerance into three main groups: aggressive, moderate, and conservative.
- Aggressive risk tolerance: those willing to take substantial risks for the chance of high returns, such as investing heavily in tech startups.
- Moderate risk tolerance: those who prefer a balanced mix of investments, such as a diversified stock portfolio alongside some bonds.
- Conservative risk tolerance: those who prioritize safety, favoring low-risk options such as government bonds or savings accounts.
What is risk capacity?
Risk capacity refers to how much risk you can realistically accommodate to achieve your financial goals. It’s a practical assessment of your financial situation and future needs. The main factors influencing risk capacity include:
- Investment horizon: This refers to the length of time you will remain invested for. When do you plan to start using your investments? If you have short-term goals, your risk capacity might be lower compared to long-term investors.
- Investment portfolio size, additions, and withdrawals: The size of your investment portfolio relative to future contributions and withdrawals is crucial. If a significant portion of your portfolio will be needed soon, your risk capacity decreases.
- Income sources: The extent to which your future income depends on your investments can impact your risk capacity. Those relying heavily on investment income may need to prioritize the stability of lower risk investments.
Required risk
Required risk refers to how much risk you need to take to achieve your investment objectives. It often represents a minimum level of risk required to meet specific financial goals. There can be instances where your risk tolerance (the risk you want to take), and the required risk (the risk you need to take), don’t perfectly align. In such cases, together with your expat financial advisor, you should carefully weigh your goals against your comfort levels.
Types of investment risks for expats in Spain
Investment risks come in various forms, each with its own unique characteristics and potential impact on your portfolio:
- Market risk: This risk arises from macroeconomic and political events that affect the entire market, potentially leading to gains or losses.
- Inflation risk: Inflation can erode the purchasing power of your money. Safer investments like bonds may offer returns lower than the inflation rate.
- Interest rate risk: Central bank interest rate changes can impact bond payments and overall market dynamics.
- Currency risk: Currencies fluctuate in value relative to each other, posing a risk that your investments’ value may decrease compared to your home currency, or you may lose if you have to transfer money between two different currencies to invest or when you draw on your investments.
- Socio-political risk: Political and social developments, both in your host country and globally, can significantly influence the value and performance of your investments.
- Liquidity risk: How marketable are your investments.
Evaluating investment risk
When conducting an assessment of an investment;s risk, there are a number of metrics and key performance indicators (KPIs) that expat financial advisors consider. Some of the factors that should be included in this assessment include:
- Beta: Beta measures a stock’s volatility in relation to the overall market. Stocks with a beta greater than 1 are considered more volatile, while those below 1 are seen as safer investments.
- Historical profitability: An investment’s historical profitability may give an indication of its potential future performance.
- Historical growth rate: An investment’s historical growth rate may also help indicate its growth potential.
- Current value vs. historic average: Comparing an investment’s current value to its historic average helps us understand potential overvaluation or undervaluation.
- Dividend history: A stock’s dividend history lets us assess its income-generating potential.
- Probable sustainability: An investment’s sustainability, in terms of its historic performance and future possibilities.
Mitigating investment risk
Diversifying your investment portfolio is a great way to mitigate the risks of individual investments, asset classes, countries and sectors. It involves a strategic allocation of assets across different asset classes, sectors and regions, all in the context of your risk tolerance and investment goals. This approach ensures that your investments align with your individual risk tolerance and are also designed to let you realize your aspirations. For instance, if you’re comfortable with higher risk for potentially higher rewards, you may allocate more to stocks or new companies or growth sectors, for example. Conversely, if you prefer lower risk, you might focus on bonds and high interest savings accounts. The goal is to strike the right balance while diversifying across various asset classes and levels of risk tolerance to achieve your financial objectives.
Final thoughts
Effectively managing investment risk is a critical aspect of your financial journey as an American living in Spain. It requires a nuanced understanding of your risk profile and an acknowledgment of the investment risks you may encounter, as well as understanding the investment options available to you. Currency risk is another important factor for expats, and your future plans in terms of where you plan to live and draw on your investments in the future will also influence where you invest and save.
While general principles provide a foundation, your unique circumstances and objectives ultimately shape your investment plan, and working with a financial advisor who specializes in working with Americans living in Spain will provide you with a great path to future prosperity.
If you have any questions about financial planning as an American living in Spain, get in touch.
This article is for informational purposes only; it is not intended to offer advice or guidance on legal, tax, or investment matters. Such advice can be given only with full understanding of a person’s specific situation.
