Should I buy my U.S. stocks in Canadian dollars?

Q. I’m a beginner investor with a small, diversified portfolio that includes a number of U.S. stocks. For simplicity’s sake, I bought these stocks in Canadian dollars and held them in my Canadian-dollar trading account. Recently it seems this is hurting my performance due to the currency fluctuations. Should I instead be buying these stocks in U.S. dollars?
–Norman

A. Adding U.S. and foreign stocks (or ETFs) is an important way for Canadians to diversify their portfolio. But buying individual U.S. securities can be confusing and potentially expensive. You’ve raised a number of good questions, Norman, so let’s clarify the key things you need to know.

First, whether you hold the stocks in a Canadian- or U.S.-dollar account has no effect on your returns. The difference you’re noticing is just an illusion. Here’s a detailed example to help you understand this important idea. (It assumes no fees or taxes, and that you are able to convert your currency at no cost. We’ll soon see why this last assumption isn’t true in the real world.)

• You bought 100 shares in a U.S. company trading at US$25 per share, for a total purchase of US$2,500 
• You bought the stock on the Canadian side of your account, and at the time, the U.S. dollar was worth $1.30 CAD, so your purchase cost in Canadian dollar terms was $3,250 .
• Over the next few months, the stock rises in its native currency and is now worth US$28.
• However, the loonie also moves up sharply, and now a U.S. dollar is worth just $1.15 CAD. The value of your holding is now $3,220 in Canadian dollars (that’s 100 shares x $28 USD x 1.15).
• You’re dismayed to learn that even though the company rose in value, you’re down $30 CAD on your investment because of the currency exchange.

But here’s the thing, Norman: the same would have been true if you had bought the stock with U.S. dollars and held it on the U.S. side of your account:

• To buy your 100 shares for US$2,500 when the greenback is worth C$1.30 CAD, you would have had to convert $3,250 CAD to make your purchase.
• If the stock rose to US$28 per share, your investment would show an increase from $2,500 to $2,800, for a gain of US$300. You might think this is a positive return, but although you have more U.S. dollars, each of them is worth a lot less.
• If you sold your shares today for US$2,800 and converted the currency at the current rate of $1.15 CAD, you would receive $3,220 CAD, or $30 CAD less than your original investment.

So assuming you measure your performance in Canadian dollars—and you should—then the currency you used to buy the shares doesn’t matter. Your portfolio will rise or fall in value by the same amount either way.

A fair exchange

In the example above we assumed that the cost of converting one currency to another was zero. Unfortunately, in the real world this isn’t the case. In fact, buying and selling U.S. dollars through your brokerage is often a raw deal.

Norman, you mentioned you bought U.S. stocks with Canadian dollars for simplicity, which is reasonable. But you should understand that when you do this, your brokerage will convert your CAD to USD at an unfavourable rate. It’s not unusual for the “spread” (that is, the difference between the rate you would pay when buying a currency compared to the rate you receive when selling it) to be 1.5% or more.

To return to our example above, if the exchange rate for one U.S. dollar is $1.30 CAD, you might actually pay $1.32 or more. Moreover, you get gouged again when you eventually sell the U.S. stock and receive the proceeds in CAD. To continue the above example, instead of receiving $1.15 CAD for each U.S. dollar, your brokerage might convert your USD at just $1.13 CAD.

Applying these rates to the example above, your 100 shares of U.S. stock would have cost $3,300 CAD and your proceeds would have been $3,164 CAD. Instead of losing $30, you would have lost $136.

Now, if you’re a long-term investor who doesn’t trade frequently and plans to hold a few U.S. stocks or ETFs for many years, it might be worth accepting this currency conversion cost. And if you’re a rookie investor, this is certainly the simpler route.

However, if you want to keep your currency costs as low as possible, you can consider a technique called Norbert’s gambit. This nifty trick involves finding a stock or ETF that trades on both a Canadian and U.S. exchange: you can then buy it on the CAD side of your account and then sell it on the USD side (or vice versa), thereby sidestepping your brokerage’s forced currency conversion.

Norbert’s gambit can be tricky, and the exact instructions are different for every brokerage. The good news is my colleague Justin Bender has created instructional videos for performing Norbert’s gambit in an RRSP at the major online brokerages. You can find them on his YouTube Channel: DIY Investing with Justin Bender.

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