Living Abroad: Using Currency Exchange Rates to Develop a Budget

When you make the decision to retire abroad, it is useful to develop a monthly budget and pay attention to currency exchange rates. To protect yourself even further, it is also a good idea to develop a long term and variable monthly budget that you can live within should currency exchange rates fluctuate greatly.

This long term and variable monthly budget should anticipate potential fluctuations in currency exchange rates. By looking at some historical data, it is possible to develop a best case, a worst case budget scenario, and a feel for future trends in the currency exchange rate.

For example, because I am living in the Philippines, I did a fairly simple analysis of the currency exchange rates between the peso and the US dollar. The graph below shows how the currency exchange rate varied from 1995 to 2009 – a fifteen year period.

Historical US Dollar to Philippines Peso Exchange Rate

Currency Exchange Rates: Will the US Dollar Grow Stronger or Weaker?

• During this 15 year period, the dollar weakened against the peso for 5 of those years, and grew stronger against the peso in 10 of those years. A very simplistic analysis would suggest that the odds in any given year for the dollar to grow stronger against the peso is 10 out of 15 or about 67%. These are favorable odds for an American retiree living in a Philippines retirement destination.
• However, a more sophisticated analysis that just looks at the past 5 years suggests a completely different perspective. During the last 5 years, the dollar grew stronger against the peso in only 1 year, and grew weaker against the peso in 4 of those years. This suggests that the odds of the dollar growing stronger against the peso is only 1 out of 5, or 20%. Unlike the 15 year analysis above, the 5 year analysis shows that the general trend in the currency exchange rates are working against the American retiree living abroad in the Philippines.

Both of the analyses provide conflicting views of the future. The 15 year analysis suggests that things are rosy for the American expatriate, while the 5 year analysis paints a less optimistic picture. Which is correct? The answer is, both are correct, because they look at what happened in the past during different time frames. What will happen in the future on the other hand, is really unknown.

However, we can still make reasonable guesses about what might happen in the future based on historical currency exchange rates. My personal assessment was that for the next year or two the dollar should remain strong, but that over time as the world pulls itself out of the recession, I expect the Philippine’s economy to recover and for the peso to regain its strength.

Currency Exchange Rates: Another Look at Probablilities

During this 15 year period, the average value of the US Dollar to Philippine Peso currency exchange rate was about 46 pesos. Without going into complicated statistical explanations, let me just say that other statistics indicate that during this period there was nearly a 70% chance that the currency exchange rate would be between 35 and 57 pesos (based on something called the standard deviation). Again, this is based upon the past and not an absolute prediction of the future.

Nevertheless, I have found it useful to use these numbers as a guide for a long term budget. When constructing my budget, I’ve used a currency exchange rate of 1 dollar to 35 pesos as my worst case scenario. And, I’ve used the 57 peso value as my best case scenario. Finally, I’ve estimated that on average, the value of the currency exchange rate will be in the area of about 46 pesos.

Currency Exchange Rates: Developing a Variable Long Term Household Budget

Hypothetically, let’s say that my retirement income is $1500 a month. And, let’s say that my monthly budget is 50,000 pesos or about $1,100 a month. This means that I have another $400 to put into savings.

My hypothetical budget looks like this:

Rental + Utilities: 30,000 pesos
Other Expenses: 20,000 pesos
Savings: 20,000 pesos

This budget works well at the current exchange rate of about 48 pesos to the dollar. Should the dollar grow stronger, I will have either more money to put into other expenses (such as food or entertainment) or into savings.

On the other hand, in the worst case scenario, should the value of the dollar drop to 35 pesos, my $1,100 budget only yields 38,500 pesos. That means I should still be able to cover my fixed expenses (rent, electricity, water, phone, condo dues, television and internet) fairly easily. However, I will only have about 8,500 pesos for other expenses (food, entertainment, transportation).

To adapt to this weak dollar I have three choices:

• I live more frugally on an 8,500 other expenses budget (which is doable, but not desirable) or
• I decrease my rent+utilities budget (which is also quite doable as I can find much cheaper rentals. However, during my first year living abroad, I opted for more costly condominium living because it provided me with security and a lot of other conveniences) or
• I shift money out of my savings and increase my monthly budget to $1,450 which restores me to my original budget of living on $50,000 a month and decrease savings to only $50 a month.

With this in mind, I am now prepared for a best or worst case scenario on my hypothetical monthly income of $1500 USD. For my chosen lifestyle, given the budget scenarios provided, it will cost me anywhere from $900 (best case scenario) to $1450 (worst case scenario) per month, with an average of about $1100 per month.

If you are living on a fixed retirement income, it is a good idea to develop a best and worst case household budget that fits within your retirement income and to make sure there is enough flexibility in your budget so that you can build some savings and adapt to changing foreign currency exchange rates.

It is impossible to predict what the currency exchange rate will be next year. However by looking at the recent past one can develop a reasonable budget plan and insure a comfortable lifestyle for oneself should you decide to retire abroad.

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