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Getting Better US Dollar Exchange

The average Canadian pays a lot more than they need to when exchanging for US Dollars.

The US is the most important market in the world, being the largest and the richest (by GDP) country. Given the proximity and historical relationship between the two countries, the US is even more important to Canada. USDCAD (the exchange rate between the US Dollar and the Canadian Dollar) is one of the most traded currency pairs in the world, and by far the largest one for Canadians.

However, for most Canadians they are losing a lot of money on the table when they exchange US Dollars for Canadian Dollars and vice versa.

As such, the US dollar is used by Canadians both for leisure (shopping road trips across the border as well as flights to New York, Las Vegas and Miami) as well as for investment (property in the US, stocks).

When someone plans on spending $10,000 in Las Vegas and they exchange that money at the bank, they are actually spending $9,800 while the bank pockets $200.

This is a finance website, and for most Canadians, US stocks make up a very large part of their portfolio. When Canadians want to buy shares of hot stocks they follow such as Google, Apple, Facebook or Amazon, they go on their online broker, punch in the number of shares they want to purchase, and suddenly they have 100 shares of AAPL.

The Hidden Fees of Investing in US Stocks

Let’s say this Canadian purchases AAPL at $125 a share. AAPL rises to $160 and the Canadian sells it. Theoretically, the profit should be $35 per share multiplied by 100 shares or $35,000 US Dollars. This is a Canadian so let’s assume he frames things in Canadian dollars. The exchange rate is 1:1 for illustrative purposes.

When he buys the stock, it should be $125 Canadian, but the broker charges him 2% to buy the stock so he is actually paying $127.50 ($12,750 over 100 shares) and when the shares appreciate he pays the unfavorable exchange rate again when he sells he receives $15,680 instead of $16,000. So while he made money, the bank implicitly took $250 when he bought and $320 when he sold.

Basically, every time a Canadian purchases a US stock, they effectively pay a 2-4% tax each time they buy or sell. This means that for a lot of investments, the stock has to appreciate 4-8% for the investor to even break even – for smaller purchases, the $10 brokerage fees to buy and sell on top of that implicit tax make it difficult to make money (the stock market is only expected to appreciate by 8% every year).

Norbert’s Gambit and How to Save Money

Fortunately, there is a way around this for serious investors. Let’s say you want to buy a sizable amount of Google but do not want to pay the unfavorable exchange rate (let’s say $10,000, your first few paycheques), which as we calculated could penalize you by $200-800 when you buy or sell.

Step 1: Open a US Dollar Account

Whether you use Waterhouse or anyone else, open a US dollar trading account as well as a Canadian account.

Step 2: Buy a Stable, Dual-Listed Stock on the TSX Using the Amount of Money You Will Use to Buy Google Stock

You are looking for a stock that trades on both the TSX as well as the New York Stock Exchange (NYSE) or NASDAQ – for example, TD Bank.

However you also want a stock that does not move a lot – so not Blackberry or an oil and gas company.

Step 3: Call the Broker and Ask Them to Journal the TSX Stock to your US Account

If you are using TD Waterhouse, call them and tell them you want to move the TD Bank stock over to the US Dollar trading account. After that, sell it in US Dollars.

Step 4: Use the US Dollars to buy Google stock.

Perform the process in reverse to get your Canadian dollars back when you want to sell.

The cost of buying and selling stocks is $1 – $10, depending on what broker you use ($1 being Interactive Brokers). As long as the amount you would save from the “tax” (see the last few paragraphs) is greater than $20, it is worthwhile to do this.

Note: Most finance professionals outside of Canada think that Canadians actually do not hold enough US and global stocks in their portfolio relative to Canadian stocks (Canadian stocks usually make up 50-75% of Canadian stockholdings whereas Canadian stocks as a percentage of global stocks is closer to 1-3%), in part due to government incentives such as dividend policy, trading complications and information from financial advisors. This behavioral phenomenon is known as Home Bias.

Why the Spread Exists

The money exchange is a business and takes risks with foreign exchange. Foreign exchange is always fluctuating and theoretically if USDCAD is trading for 1.37 (1 US Dollar buys 1.37 Canadian Dollars), they will buy at 1.34 and sell at 1.40 to make sure they do not lose money if the exchange rate moves rapidly in the wrong direction.

Realistically, if USDCAD moves by more than 1 cent over the course of the entire day, that is a large swing and not very probable.

Note: Despite the large spread, Canadian banks are relatively attractive middlemen for the average Canadian. As alluded to above, USDCAD is very relevant to Canada but less relevant to the US – a recent trip to Washington DC Bank of America offered to purchase Canadian dollars at 1.29 when the spot (real) exchange rate was 1.37.

Related Reading for Investing

Investment Asset Classes

Fixed Income – An introduction to bonds and other fixed income instruments
Index ETFs – An introduction to index ETFs and why they make sense versus most mutual funds
Avoiding Exchange Rate Fees at Banks for Investing and Travel
Real Estate
Taxes – All investors have to deal with taxes but it is important to know how to minimize tax drag on your investments through understanding TFSAs and RRSPs

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