Reducing the Cost of Currency Exchange

October 19, 2010

Yesterday’s post looked at whether US-listed ETFs are really a good deal for RRSP investors. Although ETFs from Vanguard and other American providers have dramatically lower annual fees, Canadians may face hefty currency exchange fees when trading them.

Most discount brokerages in Canada do not allow you to hold US dollars in a registered account, which means that using US-listed ETFs can involve paying a currency exchange fee when you buy, again when you sell, and every time you receive a dividend.

I’ve created a spreadsheet that helps investors compare the cost of Canadian and US-listed ETFs. With the headwind caused by a 1.5% currency exchange cost (in line with what many brokerages charge), it turns out it would take many years for US-listed funds to pay off: in my test run, a Canadian investing $5,000 annually in an RRSP would need more than 11 years to see the benefit.

If you plan to use US-listed ETFs in your Couch Potato portfolio, consider these strategies to dramatically lower your costs:

Use a brokerage that allows you to hold US dollars inside an RRSP. The only three online brokerages that do this are Questrade, QTrade (a $50 annual fee applies) and RBC Direct Investing. They allow you to link your RRSP to a US-dollar bank account and move funds into your investment account without an exchange fee, and then you can buy and sell US-listed ETFs in American dollars. Being able to hold US dollars also avoids exchange fees when you collect dividends.

Don’t resign yourself to paying 1.5%. You can probably live with a high currency exchange fee if you’re only collecting a hundred bucks a year in US dividends in your RRSP. But if you’re regularly exchanging currency inside your investment accounts, you really need to find a better deal. Many brokerages don’t publish their currency spreads because they would rather you not know how much they’re gouging you. One exception is Questrade, which charges just 0.5%. (Does anyone know of other discount brokerages that can compete with that? Please share your experiences below.)

Learn how to wash your trades. If your brokerage does not allow you to hold US dollars, it may allow you to “wash your trade.” This technique allows you to sell a US-listed stock or ETF and temporarily park the proceeds in a US-dollar money market fund. Then you can buy a different US stock or ETF with those dollars and avoiding paying a currency exchange fee twice. For more information, see these posts from Michael James and Canadian Capitalist, then call your brokerage for instructions.

Consider “Norbert’s gambit.” My spreadsheet assumed that our investor would eventually sell his entire position in the US-listed ETF after a couple of decades, at which point it would be worth six figures. In reality, paying anything like 1.5% when exchanging a large sum like this is insane. If you’re looking to exchange a large amount of US dollars (say, $10,000 or more) consider the innovative method popularized by Norbert Schlenker of Libra Investment Management. Nicknamed Norbert’s gambit, this involves buying a highly liquid interlisted stock (that is, one that listed on the TSX and a US exchange) in one currency and then having your brokerage “journal it over” to the other currency before selling it. This isn’t for the novice: read this these threads on Financial Webring and Canadian Money Forum first, then call your brokerage and ask about the specifics.

Hold your US-listed ETFs in a taxable account. If you can’t tax-shelter all of your investments, the usual advice is to put your Canadian equities in a taxable account, since the capital gains and Canadian dividends get the most favourable tax treatment. However, some investors may find it makes sense to hold their US-listed ETFs (or dividend-paying stocks) in a taxable account. Yes, you will pay a 15% withholding tax on the dividends, but this may be recoverable, the capital gains are still taxed favourably, and you get the benefit of generating income in US dollars, which you can use for travel or making online purchases.

{ 34 comments… read them below or add one }

Canadian Capitalist October 19, 2010 at 12:52 pm

Thanks for the mention Dan. I’ve used the Norbert Gambit to convert CAD into USD a couple of times. Works as advertised and you can exchange at close to the spot rate at just the cost of two commissions.

Canadian Couch Potato October 19, 2010 at 12:56 pm

@CC: Which stock did you use?

I always thought it would be cool to have a gambit named after me.

Michael James October 19, 2010 at 1:00 pm

Thanks for the mention. It seems that the mechanism for washing trades is slightly different for each brokerage. A coupe of times Investorline allowed me direct access to FOREX trading through one of their representatives when I was converting more than $100,000. The spreads were low, but how often do people convert more than $100,000?

Slacker October 19, 2010 at 1:35 pm

The more I think about it, the more I feel like ditching TDWH. The currency conversion rate, foreign dividend conversion in RRSP, and commission are all eating into my savings. I haven’t done the math on how much, but I have a feeling I won’t like it.

Questrade, here I come.

BTW: I also ditched ING direct for Ally. I am an ungrateful cheap bastard. :)

Simon October 19, 2010 at 3:28 pm

Interactive Brokers will allow you to convert from USD/CAD and vice versa for less than Questrade’s 0.5%.

http://www.interactivebrokers.com/en/p.php?f=commission

Even under their non-professional rates, they only charge 0.01% on the conversion, with a minimum charge of $2.50. You can then transfer this USD into Questrade directly, avoiding the FX fees.

W. Williamson October 19, 2010 at 3:32 pm

When I recently purchased US-listed ETFs in my RRSP, Scotia iTrade charged me (by my math) 1.65% for the one-way CDN-USD conversion.
(Which is about 100X what an institutional investor actually pays to exchange CDN for USD.)

Which means that for every $60,000 I invest in US securities, iTrade immediately takes $1000 from the my RRSP as profit.
(And then another $1000 on the way back.)

Canadians that worry about whether they’re paying $9 or $29 for trades are missing the forest for the trees.

With currency conversion fees like these, I’m certain that the popularity of Vanguard-ETF-laden lazy portfolios has been a giant profit windfall for Canadian discount brokerages.

Slacker October 19, 2010 at 4:43 pm

@Simon: Yes, interactivebrokers sounds awesome. Let me check them out. I’m very tempted to switch from TDWH to a combination of Questrade + InteractiveBrokers. I have come to realize that unlike active investors who try to beat the market, I can’t shrug off the cost of maintaining my portfolio. I need EVERY edge I can get !!

Canadian Couch Potato October 19, 2010 at 5:03 pm

Just a note to readers that Interactive Brokers is designed for very active traders, not Couch Potato investors. They do not even offer RRSP accounts. Make sure you understand all of the fine print before making any switches.

Phil October 19, 2010 at 5:33 pm

Any idea how transferring a US ETF in-kind from a non-registered USD Trading account into a RRSP would work? Could that potentially reduce any of the conversion fees?

Financial Cents October 19, 2010 at 6:42 pm

Wow…

“With the headwind caused by a 1.5% currency exchange fee (in line with what many brokerages charge), it turns out that it would take many years for US-listed funds to pay off: in my test run, a Canadian investing $5,000 annually in an RRSP would need more than 11 years to see the benefit.”

Great to know Dan.

DM October 19, 2010 at 7:47 pm

Thanks for this analysis Dan. This is very useful stuff. Like W. Williamson, I also use iTrade and am dismayed with their forex spreads. Canadian Capitalist did a piece a little while back on forex fees charged by different brokers and unsurprisingly Scotia iTrade was determined to be the worst. On your spreadsheet, if you assume there is no 15% witholding tax on dividends (which, of course, is the case for all of the Canadian ETFs that I own, such as XIC), the US denominated ETFs never break even over the 30 year horizon. This simple analysis has caused me to reconsider whether I should be investing in VTI, VEA and VWO. The problem is there is not a comparable substitute for these ETFs that trades in CAD and that does not hedge currency risk.

W. Williamson October 19, 2010 at 8:47 pm

On his blog, FrugalTrader lists foreign exchange fees charged by some of the Canadian brokerages:

http://www.milliondollarjourney.com/review-canadian-discount-brokerages.htm

It’s unclear how recently this data was updated (the blog entry is originally from 2006), though it doesn’t contradict the recent anecdotal evidence I’ve seen.

Canadian Couch Potato October 19, 2010 at 9:02 pm

Thanks for the useful comments, everyone. I do think it’s worth clarifying some points, as it sounds like a number of readers are questioning whether they should ever use US-listed ETFs at all.

First, my spreadsheet assumes a worst-case scenario, where the investor is paying a very high currency exchange fee, and is doing so when buying and when selling. As I mention in today’s post, long-term investors who end up with five-figure positions in a US-listed stock or ETF would be foolish to cash out at a rate of 1.5%. There are always better options.

Second, it really isn’t useful to compare the cost of VTI, VEA and VWO to Canadian equity ETFs, as several readers have done. They are completely different asset classes. The currency exchange is certainly an issue, but it’s not a reason to abandon international equities in your portfolio. And choosing a Canadian-listed alternative like XSP, XIN and CWO means adding currency hedging, which carries significant costs of its own, as well as a very different investment objective. I’ll have more to say about this later in the week.

Finally, remember the most important lesson from the spreadsheet: even with the 1.5% exchange fee on the way in and the way out, the US-listed ETFs are still cheaper for the long-term investor. If you’re looking at a 20- or 30-year investing horizon, the difference is dramatic. If you’re able to mitigate the currency exchange issues with some of the suggestions above, you are still likely to be much, much better off with Vanguard.

Slacker October 19, 2010 at 9:22 pm

Using the gambit, along with switching to Questrade will decrease my forex handwind from 1.5% to 0.06%. That is a factor of 22 times. The US-listed ETF has an advantage beginning in the first year.

Money Smarts Blog October 20, 2010 at 9:51 am

@Simon & @Slacker

Like Dan said, IB is for active traders.

They only have non-registered accounts which makes it useless for most Canucks. No RRSP, TFSA, RESP, RRIF accounts etc.

They also have a $10/month minimum trading fee so if you are a couch potato, then you probably won’t save much on trading commissions.

There is also a $10,000 account minimum.

Chris October 20, 2010 at 9:54 am

I used Norbert’s Gambit just last week to purchase a large amount of US$ in my BMO cash account. The offered FOREX was ~0.49% on a direct currency swap. I didn’t calculate the cost of a combined FOREX/trade would have been but my guess is that hidden fees are always more expensive. The BMO rep offered a slightly better rate (~0.45%) but not a big difference.

I used POT (based upon a quick comparison of liquidity/spread of a few cross listed stocks). I found a handy site linked from Financial Web Ring that calculates the real-time cost based upon the current spreads & FOREX charges for a variety of cross listed stocks). POT was always ahead by a wide margin so I didn’t bother spending too much time investigating the rest.

The first thing I learned is that BMO second-level quotes are nearly useless. Either things are moving way too fast or BMO’s info is just wrong. In my experience, the second ask is ~5% away from the current trades and the first ask is for a tiny number of lots; at the same time the volume is jumping by thousands every split-second at a stable price. Ignoring the “information” that some people actually pay more for, I jumped in when the time was right.

How did I find the right time? Well, POT bounces around quite a bit and it’s difficult, even with a blazing fast net connection, to get a good handle on things. It took a few days of playing around (I do have a full time job that I’m supposed to be doing) before “it” happened. There was a brief period where POT was actually cheaper to buy (in USD) than to sell (in CND). My unexpected arbitrage provided a FOREX charge of -0.06% after fees. Yes, it was actually a slightly positive return in a calm price period with high volume.

I have to admit, it was quite a rush. I was a little tingly for a few minutes. It felt like gambling, which was exactly what I was trying to avoid. I highly doubt I’ll do this again, for a few reasons:
1) This was a one-time major rebalancing of my portfolio.
2) It’s just more work (and more risk) than I was interested in.
3) I don’t intend to ever buy or sell another lump sum large enough to make this worthwhile again.
4) If this does happen again, it will be by my heirs and not my direct concern. :-)

Canadian Couch Potato October 20, 2010 at 10:22 am

@Chris: Thanks for sharing your experience. I admit it all sounds a little nerve-wracking, especially for people who are not used to a lot of trading. Glad it worked out for you!

Canadian Capitalist October 20, 2010 at 10:29 am

I used RIM. It is very liquid but also very volatile. Best to pick a slow news day.

http://www.canadiancapitalist.com/saving-on-currency-conversion-an-example/

Christina Norman October 20, 2010 at 8:04 pm

I just did two Norbert’s Gambit trades with RBC Direct Investing. I made money on one, and the % cost worked out to 0.055 on the second one. I’m going to write up my experience as a blog post I’ll post a link back here when that’s done.

I purchased shares of RY in my canadian account, sold RY in my US account, and the rest of the experience was entirely automatic. About as hassle free as you could imagine.

Christina Norman October 20, 2010 at 10:55 pm

Here are two blog posts where I explain in detail how I used Norbert’s Gambit to convert CAD to USD, and USD to CAD, using RBC Direct Investing.

Introduction – http://www.christinanorman.com/2010/10/using-rbc-direct-investing-for-norberts.html

Detail of both Trades – http://www.christinanorman.com/2010/10/using-rbc-direct-investing-for-norberts_20.html

Hope this is helpful to other Canadians looking to save money on currency trades!

Canadian Couch Potato October 21, 2010 at 7:43 am

@Christina: Many thanks for sharing this. Great detail!

NorthernRaven October 22, 2010 at 6:04 pm

Don’t forget that at least some discount brokerages may have sliding scales on their conversion rates as the amount goes up. TD Waterhouse seems to start at around 1.4%, but it seems to be a bit lower (1.3%?) at around $15,000, ~0.8% kicks in around $35,000, and 0.67 or so at around 60-65000. They don’t post their rates, so I’ve been using their WebBroker forex screen to get quotes on amounts for CAD-US and then the reverse, and assuming the midpoint is between the two. I don’t know if this is for all customers – I’ve got over the $100K that activates the $10 trades and so on, but nowhere near the $500K (don’t I wish) for President’s account, and my account is relatively new, so I can’t be that special.

They’ve also said that for amounts over US$60,000 that you can usually call and book a better rate. I tried, and the rate I was quoted on a hypothetical $100K transaction worked out to around 0.3%. Definitely worth checking out if like me you are considering doing a large one-time lump transfer into $USD.

@DM: I couldn’t find the post from CC you mentioned about comparative forex rates at the various brokerages – do you have a link?

Chris October 23, 2010 at 4:33 pm

No, I don’t have much trading experience. I want to be on the “15 minutes per year” plan; trading enough to gain experience is contrary to my needs.

Reducing costs is of decreasing utility. Getting the lowest possible costs means a big investment in either personal time or experts, both of which come with other costs, contrary to the goal.

By the way, I just learned of a new US tax on stock transactions. It’s tiny, but it does show up on large transactions. It appears to be about 0.002%.

Chris B November 17, 2010 at 2:11 pm

I am in the process of setting up my RRSP account and would like to purchase US ETF. I am using CIBC Investor’s Edge and qualified for a discount transaction fee of 6.95 per trade. After reading the article I called and asked about currency exchange fee and they told me that they do not charge currency exchange fee, just the daily exchange rate.

Am I missing something??

Chris

Canadian Couch Potato November 17, 2010 at 2:23 pm

@Chris: My guess is that they’re just being sneaky. They don’t specifically charge a fee, perhaps, but their daily exchange rate has a profit built into the spread. For example, if the Canadian dollar is at par, they’re probably selling it for $1.02 and buying it for $0.98. It’s probably best to ask them for their daily rate and see how that compares with the official exchange rates quoted online at places like Google Finance.

Chris B November 17, 2010 at 3:16 pm

Thanks for the quick respond. (Wish my old advisor was as fast as you are)

I will keep a close eye on it.

Cal July 12, 2012 at 5:18 pm

Questrade doesn’t charge 0.5% for currency conversions. I have done several transactions with Questrade and noticed fairly large discrepancies between the forex rate and the conversion, so I inquired with the customer service and they told me that all transactions are charged 1.99% spread. Avoid currency conversions through Questrade.

JohnH February 15, 2013 at 10:33 am

I can confirm what Cal says. The default rate is 1.99%.
But I did get a better rate (1.0%) without asking, presumably because I was converting $38,000. A help desk guy said to call the Trade Desk and ask for a better rate if the amount is large.

Marc N April 10, 2013 at 12:38 pm

I just did a test on RBC Direct Investing to convert USD to CAD and compare the rate they give with the spot rate on xe.com. From my test, it looks like there is three tiers of rates:

up to $25,000 — 0.85%
$25k – $75k — 0.67%
$75k+ — 0.35%

Note: these values have some degree of error involved but they should be close to what you get. I wasn’t able to test past $250k so I don’t know if there is a tier above that. Also, I wasn’t able to test the conversion from CAD to USD but I assume it uses a similar spread and/or tiers.

Canadian Couch Potato April 10, 2013 at 3:49 pm

@Marc: Those spreads actually sem pretty tight for a retail brokerage. Also remeber you can use DLR and do Norbert’s gambit at a cost of about 0.20%, plus the trading commissions.

Marc N April 10, 2013 at 4:10 pm

Yeah I was expecting ~1.5% like most other institutions, so I was actually pleasantly surprised. I’ve done Norbert’s using DLR/DLR.U and it’s pretty easy on RBC DI – you don’t even need to phone a rep like you do in some other brokerages (such as BMO Investorline).

Kerri April 10, 2013 at 8:53 pm

I am curious if TD Cash acct’s are still able to complete the NG trade? I have not read any recent posts regarding TD Cash accts. I spoke to a rep on the phone today and it was like I was talking Greek to him (he quoted typical 1.5%). If I do try it, it will be like the one post I read “call them and get the go ahead prior to completing the ‘buy’ side while you are on the phone”.

Canadian Couch Potato April 10, 2013 at 9:30 pm

@Kerri: I’m not sure what you mean by “TD Cash accounts.” Are you referring to the USD money market funds that TD uses to wash trades?

Joe November 12, 2013 at 4:58 pm

Questrade just charged me ~1.7% for a CAD to USD exchange around $10k. Pretty expensive.

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