We just sold our condo in Florida and now have some money to invest in non-registered accounts. The problem is, the money is all in American dollars. Is there a way to use the Couch Potato strategy using only USD? – John D.
It’s certainly possible to build a fully diversified ETF portfolio using only US dollars, but there are a number of important issues to consider.
The first is whether you really need to keep the money in USD. If you don’t plan to make another major purchase in the United States (or if you earn a lot of USD income but all your expenses are in Canadian dollars) it might make sense to exchange most or all the money into your home currency before investing it. Of course, you will need to find a low-cost method for doing this, such as Norbert’s gambit.
You also need to consider your overall asset location. Holding fixed income, Canadian equities, and foreign equities in a non-registered USD account probably isn’t the most tax-efficient strategy. Even if your registered accounts are maxed out, you can still make changes so your fixed income stays in Canadian dollars in RRSPs and TFSAs, and only your equities are in US-dollar taxable accounts.
Let’s consider each asset class in turn:
Fixed income. One of the most important roles for bonds in a diversified portfolio is to lower volatility. For that reason, it is usually unwise to take currency risk with fixed income. Sure, you can buy something like the Vanguard Total Bond Market ETF (BND), but you shouldn’t make it your core bond holding if your expenses and liabilities are in Canadian dollars. However, if you are a long-term investor who ultimately plans to spend your portfolio in US dollars, then a fund like BND may well be appropriate.
If you want to keep US dollars in GICs—which are preferable to bonds in taxable accounts—the options are not very appealing. Canadian financial institutions offer US-denominated GICs, but the rates are generally low. (At ING Direct, for example, business customers get 0.75% for one year and 2% for five years.) What’s more, the “G” in GIC doesn’t apply: US-dollar certificates do not qualify for CDIC insurance. The challenges are similar for US-dollar investment savings accounts: the rates are terribly low (currently about 0.20%) and the products are uninsured.
Bottom line, if your bonds, GICs, and cash are part of a long-term portfolio, it really is preferable to hold them in Canadian dollars.
Canadian equities. It’s quite unusual to find yourself in a position where you’re investing in domestic equities using foreign currency. But if you want to follow the standard Couch Potato strategy of holding about a third of your equities in Canada, there are ways to do so with USD.
One option is to use the Horizons S&P/TSX 60 (US$), which has the ticker symbol HXT.U: it trades on the Toronto Stock Exchange in US dollars. (Before investing in this fund you should understand its swap structure.) If you’re investing in a non-registered account, this is likely to be your best bet because of its extremely low fee and tax-efficiency.
You might use a US-listed fund such as the iShares MSCI Canada (EWC), but this ETF is expensive (from an American perspective, it’s a foreign equity fund) and you won’t be able to claim the dividend tax credit. Because it is a US-domiciled fund, you will receive a T5 rather than a T3 slip, and your Canadian dividends will not be itemized.
An important note about currency risk here: although you are buying in US dollars, the underlying stocks are denominated in loonies. That means if you measure your returns in your home currency it would make no difference whether you held HXT.U or its Canadian-dollar equivalent, HXT. Your returns would be identical.
US and international equity. These asset classes are obviously much easier to access with US dollars, since you can simply use the Vanguard ETFs that are already in the Complete Couch Potato: the Vanguard Total Stock Market (VTI) and Vanguard Total International Stock (VXUS). Another option for US equities is the BMO S&P 500 – US Dollar Units (ZSP-U): like the Horizons fund above, this one trades on the TSX in American dollars.
Finally, if you have a very large portfolio, make sure you stay up to date with US estate tax laws, which changed in early 2013. ETFs listed on New York exchanges are considered “US situs assets,” and therefore may be subject to estate taxes upon your death. However, Canadian-domiciled funds such as HXT.U and ZSP-U are not, even though they are denominated in USD.
Would it be possible to do the currency gambit with ZSP and ZSP.U ?
I want to transfer from TDW to Questrade in kind using ZSP. Once in Questrade, journal it to ZSP.U, sell it for USD, then buy US stocks.
What you do you think?
@Jungle: Yes, it should be possible, as long as Questrade allows Norbert’s gambit. Some investors have reported problems with this in the past:
Re: “Finally, if you have a very large portfolio, make sure you stay up to date with US estate tax laws, which changed in early 2013. ETFs listed on New York exchanges are considered “US situs assets,” and therefore may be subject to estate taxes upon your death.”
It is my understanding that you are not subject to any U.S. estate tax if the property is held in a registered account.
@Bernie: From Jamie Golombek’s article, which is linked in the original post: “The most common examples of U.S. situs property are U.S. real estate, such as a Florida or Arizona condo, or shares in U.S. companies, even if they’re held inside Canadian brokerage accounts, including RRSPs, RRIFs and TFSAs.”
According to CCRA Form T1135 E (07) – FOREIGN INCOME VERIFICATION STATEMENT
“A trust governed by a RRSP does not have to file Form T1135.”
One common reason for purchasing EWC (owning Canadian equity in a US dollar account) is if you are a dual US/Canadian citizen. In a taxable account, the IRS has a very punitive tax treatment of Canadian domiciled mutual funds and ETFs. They consider them to be “passive foreign investment corporations” which have terrible reporting/paperwork requirements. At least in my case, my only option is to either own EWC or try to build the TSX60 index myself using individual stocks. Despite the 0.5% MER and less favorable tax treatment, it is still way easier than trying to replicate the index on my own.
Thanks CCP. Yes I have read about the gambit with Questrade. Seems like TDW is the easiest, apparently you don’t even have to journal in an rsp. You can just sell right away.
@Joel: That’s an interesting challenge I did not know about. Thanks for sharing.
Slightly off-topic, but I can report successfully completing a Norberts Gambit at Questrade a week or two ago. I used DLR and DLR.U to buy USD. You have to call their trade desk to journal the shares over. But when I did, I got a nice lady on the phone who knew exactly what I was doing, journaled them over, and sold them right there for me. Total cost was one $4.95 trade, plus about 70 cents in ECN fees, and a 5 min phonecall.
I recently did a gambit with questrade using DLR. No major problems, but call the trading desk directly to avoid delays (no extra fees involved). You do have to call to sell DLR.U, but it can be done at the same time as the journal.
@Danno and Owen: Thanks for confirming this is possible.
Also slightly off topic. I heard that the new federal budget is closing whatever loophole/rule it is that allows mutual funds and etfs to be tax efficient by converting interest income to capital gains… will this affect HXT or any other popular etfs?
What would be nice is if they would increase TFSA contributions to the same as RRSP limits (never happen). Perhaps someone would be able to convince the Feds that their tax revenues would actually increase if they did! (Because people would load up their tfsa room first.
Flagren if the FED does that it is going to be hell in investors in non registered accounts. It will not go over well at all.
@Flagen: Good to hear from you again. I have been gathering info on this issue and will will be reporting on it next week. For now I can say that Horizons does not believe HXT will be affected.
Hi me again, sorry to rehash, but zsp and zsp.u have different CUSIP numbers, do you think you can gamit with this one?
CUSIP: 05575T 10 0
CUSIP: 05575T 11 8
I am looking for suggestions for producing US$ income to pay for renting a place in Florida – I don’t want to buy at this time. Any ideas about a US$ denominated ETF that pays dividends that qualify for the Canadian dividend tax credit ?
@MAF: The ETF you describe would have to be a Canadian-domiciled, US-denominated fund that holds Canadian stocks. I am not aware that any such product exists.
Is anyone aware of a similar site like American Couch Potato.com which would have back-tested American ETF portfolios?
I have a question about this part of the article
“You also need to consider your overall asset location. Holding fixed income, Canadian equities, and foreign equities in a non-registered USD account probably isn’t the most tax-efficient strategy. Even if your registered accounts are maxed out, you can still make changes so your fixed income stays in Canadian dollars in RRSPs and TFSAs, and only your equities are in US-dollar taxable accounts.”
Why is it not efficient to hold foreign USD equities in a non registered account? If I understand correctly (assuming your registered accounts are maxed out) holding USD equities is no less efficient than CAD equities in non registered accounts.
For fixed income, aside from the currency risk, isn’t a USD bond ETF just as tax efficient as Canadian in an RRSP?
@Daniel: Looking back at this old post I see that the paragraph you highlighted is very poorly written. :( The point I was trying to make is that if you have a lot of USD to invest in a taxable account, it makes sense from a tax perspective to use all of those funds to invest in US-listed equities (and not US-listed bond ETFs). Then, to make sure your overall asset allocation (and risk level) is still appropriate, you can adjust by holding fewer equities and more bonds in your RRSP.
I regret suggesting that more fixed income should be held in your TFSA, as this generally is a poor choice, since low-growth assets aren’t the best use of a tax-free vehicle like a TFSA.
You are, of course, correct that a US bond ETF is not tax-inefficient in an RRSP.