A recent note from a reader prompts me to reprise the topic of forced foreign currency conversions in registered accounts such as RRSPs, TFSAs and RESPs at many discount brokers. The self-directed registered accounts offered by most discount brokers are denominated in Canadian dollars. When an investor purchases a stock or ETF that is trading on the US exchanges, the broker charges a mark up when converting Canadian dollars into US dollars or vice-versa.
Let’s take a concrete example. If the CAD and USD are trading at par, an investor buying $10,000 (US) worth of Johnson & Johnson (NYSE: JNJ) would pay $10,150 in Canadian dollars because the mark-up on foreign exchange conversions is typically 1.5%.
Fast forward a few months and our investor is frustrated with the flat-lining performance of JNJ. She wants to sell the dog and buy another stock, say Disney (NYSE: DIS). The dollar is still at par and our investor assumes that when she completes her two transactions she will own $10,000 (US) worth of DIS. Sadly, she is mistaken. Our investor holds JNJ in her RRSP account and her broker doesn’t offer a way to save on foreign currency conversions. When she sells $10,000 (US) worth of JNJ, the broker will first convert USD into CAD and our investor is left with proceeds of $9,850 (CAD). And when she turns around and buys DIS, the broker will convert CAD back into USD and our investor will now have just $9,702 worth of DIS shares. She has lost 3% of her investment in needlessly converting USD into CAD into USD.
Fortunately, some brokers provide their clients a way to avoid these expensive and hidden foreign exchange conversions. TD Waterhouse’s wash trading allows investors to park proceeds of US dollar trades into the TD US$ Money Market Account. RBC Direct Investing, Questrade and QTrade offer ways to settle US stock trades in US dollars. Scotia iTrade now offers a US-friendly RRSP. Even BMO InvestorLine sort of allows wash trading for clients jumping through some hoops. Clients who have accounts at the few holdouts should demand that their broker offer a way to avoid punishing foreign exchange conversions. If the brokers fails to heed their demands, they should vote with their wallet and move their accounts to a broker who doesn’t penalize buying and selling on the US exchanges.