In a recent post, Canadian Couch Potato wondered if US-listed ETFs are really cheaper than Canadian ETFs considering that a Canadian investor incurs a 1.5 percent currency conversion charge in buying and selling a cheaper MER product. Dan constructed a model and found that:

… the US-listed ETF doesn’t take the lead until year 7 with lump sum contribution, and it takes 11 years to break even with the $5,000 annual contribution.

The fees involved in exchanging currency isn’t the only drawback to US-listed ETFs. US-listed ETFs such as the popular Vanguard VIPERs are considered US located property and might be subject to US Estate Taxes.

Despite the twin drawbacks of currency conversions and US Estate Taxes, I prefer to hold US-listed ETFs due to the following reasons:

  1. I fall in the camp that believes that the costs involved in currency hedging is unlikely to be a profitable strategy for a long-term investor due to the costs involved (it’s not just the higher MERs — currency hedged ETFs show terrible tracking errors). Unfortunaltely, as I mentioned in my wishlist for ETF products, currency unhedged Canadian ETFs are not currently available for the US total market and EAFE markets.
  2. Even in the emerging market category, the iShares MSCI Emerging Markets ETF (TSX: XEM) has a MER of 0.82%. But the Vanguard Emerging Markets ETF (VWO) is substantially cheaper at just 0.27%. All things being equal, VWO should take the lead over XEM after just 3 years assuming no growth in the investment.
  3. But all things are not equal. Foreign investments are best held in a RRSP account because of the harsh tax treatment meted out to foreign dividends. A US-listed ETF held in a RRSP also escapes US withholding taxes. Not so for Canadian ETFs that hold US-listed stocks or ETFs. A 2 percent dividend yield will translate into an additional 0.30 percent annual cost (at a 15 percent withholding tax rate) for a Canadian ETF holding US-listed stocks or ETFs and held in a RRSP account.
  4. It is true that retail investors pay a typical currency conversion charge of 1 to 1.5 percent. But as Dan points out in another post, there are ways to avoid this charge. One popular method is to ride the coattails of arbitageurs and get close to the spot rate for just the cost of two commissions. Wash trading can be employed to avoid currency conversions when selling and buying US-listed ETFs.
  5. And the #1 reason? As a long-term investor, I’ll be holding these ETFs for 30 years or longer. At the end of 50 years, $100,000 invested initially in a US-listed ETF will be worth 20 percent more than the Canadian ETF even after paying conversion charges of 1.5% on the initial buy, the final disposition and annual dividend payments. Those tiny MER and tax differences do make a dramatic difference for the long-term investor.

Update: Comments were not working for the past couple of days. It should be fixed now.

This article has 30 comments

  1. There is no rule that you either need to hedge everything or hedge nothing. You don’t need to be firmly in one camp over the other. I hold VTI (no hedge) for my US equities component and hold XIN (hedged) for my international component. I also hold VWO simply because the MER is significantly lower than the Canadian alternatives. If you are a long term investor just set your portfolio and don’t lose sleep over the potential for wild currency exchange rate fluctuations on the one hand and tracking errors on the other.

  2. Excellent case Ram, thanks for sharing your views. Sounds like the long-holding period is really the determining factor.

  3. When it comes to currency-conversion charges, I think the main thing to avoid is getting hit multiple times on the same assets. This is mainly a concern for active traders.

    It would be nice to have enough investors complain so that brokers stopped charging more than 10X their real costs of currency conversion.

  4. I believe that Questrade is slightly cheaper at 1% so that helps a bit. What if one did not have RRSP contribution room and wanted to invest in a unregistered account… would you still recommend the US-listed ETFs, if one were holding for the long-term?

  5. Well laid out Ram. Thanks for the education on the different ETF’s and their features.

  6. I asked this in response to the Coach Potato Portfolio posting but didn’t see a response, so will try here – if I buy a US-listed ETF (VEA, VIG etc.) in an open USD account and then transfer the asset in-kind to my RRSP at TDWaterhouse, do I avoid all the currency conversion mess? I understand it will still bite me at dividend time…

  7. @Greg: Currency hedging is much debated but due to the lack of data we can’t make definitive statements. I’d be interested why you prefer to hold XIN instead of EFA or VEA.

    @Financial Cents: I think so. Equities are not the place to be if holding period is less than 20 years. That’s a sufficiently long time period for small MER differences to add up.

    @Michael: Agreed. When I sold my US holdings and purchased VTI, I moved accounts to TD Waterhouse from RBC Direct Investing simply to take advantage of wash trading. RBC Direct at that time did not offer separate US Dollar RRSP accounts.

    @Invest It Wisely: Unfortunately, Questrade isn’t an option for me. I’ve been burned by them before and a cheaper currency conversion charge is no reason for me switch.

    @Phil G: Yes, you can transfer US-listed stocks or ETFs in-kind from a taxable account to your RRSP without incurring any foreign exchange conversion charges. You have to watch out for tax consequences though. When you make an in-kind contribution, you’ve done a deemed disposition. If you have capital gains, you’ll have to pay taxes on them. If you have capital losses, you cannot claim them.

    I’ve personally done this multiple times. One nice advantage is you can pick any price between the day high and low (previous day’s prices if you do this after market hours). Hmmm… this sounds like a good topic for a post.

  8. As with any investment, there are a lot of variables. Some personal (age to retirement, etc) and some financial. If you have US ETF or stocks in your RSP you need to open a USD RSP at additional cost otherwise dividends will be converted to CAD (plus convesion costs). Even if you DRIP your stocks, you can accumulate a substantial uninvested amounts. Now pay broker commissions for another stock since there is interest cost and so on and on.

    Solution? Don’t invest in foreign markets until your portfolio is over 100K to make all the hassles (there is cost to time spent too!) and all other costs worthwhile.

  9. If I recall correctly Interactive Brokers has no mark-up on currency conversions (and charges $1 commission per board lot on many transactions).

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  11. I thought I would check to see if my memory was right about Interactive Brokers offering currency conversions without mark-ups. It seems that’s the case. Here is a quote from a review of Interactive Brokers from blogger Divestor (also invests through them):

    “I am kind of amused at discussion forums asking where you can get the best rates to converting currency – most brokerages charge a 2% spread. With Interactive Brokers, the spread is the market, which is usually around 0.0001 for the CAD-USD pair. For people that do cross-currency transactions, this amounts to substantial cost savings.”

    So someone investing a lot in U.S ETFs or stocks could use a broker like Interactive Direct

  12. @CC: Wanting XIN over VEA was not the basis of my decision. I do prefer VTI and the index that it tracks to the US equity ETFs that trade on the TSX. Since I wanted a portion of my non-Canadian investments to be hedged and a portion to not be hedged, my only real choice to do that was with XIN.

  13. Based on a previous Canadian Capitalist post I decided to try Norbert’s Gambit to save money on currency conversion using RBC Direct Investing. I wrote this up on my blog.

    Introduction –

    Detail of both Trades –

    Summary – it is really easy to do it with RBC Direct Investing.

    @CanadianCapitalist can you tell me where your 63 basis points stat in the below article came from?

    • @Christina: Thanks for the mention of my post. I was told that TD Waterhouse will charge a higher fee for placing the second transaction with an investment representative. These broker assisted transactions are more expensive.

      When I actually performed the Norbert Gambit, I was only charged two Webbroker commissions of $9.99. Also, I used RIM because it is more liquid than Royal Bank. Potash (POT) was another suggestion I received for a liquid stock.

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  15. You cannot predict currency fluctuations, one way or another. I think a relevant consideration is where will you be spending your retirement income. If it is in Canada, my preference is to hedge. We have entered into a new era where the Canadian dollar is now considered a “Petro” currency. If you’re an adherent to the peak oil theory (as I am), then the Canadian dollar will remain above par the US currency for quite some time. Looking at historical rates of currency does not give you a clear picture about where the currency will land. IMHO, the risk with unhedged positions, irrespective of savings in fees, is not worth it.

  16. You say that rrsps are the best place for foreign etfs. My rrsp is 100% laddered gics. I was planning on using my non registered account for etfs exclusively which would include some foreign exposure using Vanguard etfs. I’m looking at holding these for at least twenty years. Is this a bad strategy? I read your post every day. Thanks for all the useful information.

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  18. @Paul: Yes, currencies fluctuate a lot but these fluctuations should not be viewed in isolation. Instead, they should be seen in the context of the overall portfolio. Due to low/negative correlation between currencies and stocks, historically holding a currency unhedged investments does not greatly increase portfolio risk.

    @Kevin: Bonds should be kept in a RRSP account over foreign ETFs. If there is no RRSP room, then, of course, the foreign ETF has to be held in a TFSA or taxable account. If a US-listed ETF is held in a taxable account, the calculations for break even would change depending on tax bracket but I would venture to guess that the US-listed ETF would still come out ahead over the long-term but take longer than the illustration here if you only look at holding costs.

    In a taxable account, the key consideration is whether you need currency hedging or not. If you need hedging, then it has to be Canadian ETFs. If you don’t need currency hedging, US-listed ETFs might be the better choice.

  19. Profile Investor

    I have a fairly generous stock program with my American employer. When I become over weighted in company stock, I sell and transfer the proceeds in US dollars to a self-directed US account. I use this money to invest in Vanguard ETF funds. In retirement – not 30 years but more like 10 – I plan to withdraw as needed into a US bank account and use the money to snowbird in the winter. The plan avoids all transaction costs.

  20. May I ask exactly how you organize your $US dollar etf investments at TD Waterhouse, without the benefit of a $US RRSP account?

    That is the situation I am currently in and, although I haven’t been burned by Questrade, I am new to discount brokerages and would prefer to have a little hand-holding if I need it as I set up my couch potato strategy.

    I’ve been following the posts on $US investing here and on couchpotato blog, so I’ve understood all the various strategies to reduce exchange costs and to use US listed etfs for their cheap fees. What I’m less clear about is which ones will work most effectively given the possibilities at TD.

    Most of our portfolio is in RRSPs, maxed out TFSAs and some is in an open account.

  21. And… your final paragraph doesn’t match Couch Potato’s spreadsheet. That 20% is achieved at 20 years (not 50) with the lump sum investment.

    Was that a typo or did you do a different calculation?

  22. I’m an older neophyte to many investing matters, so have a few questions for you. From what I can see above, a key reason you prefer Vanguard EFTs is that their low MERs will be a great advantage to growth if you hold them for 30 years or more.

    My research indicates that Vanguard ETFs are a fine product and I want to buy a number of them. But I’m 61. If I buy Vanguard ETFs now inside my RRSP, the law will allow me to hold them in that way only for 10 years, to age 71. I plan to work until 76 or 77 because I’m not the retiring kind and will be buying ETFs for some time.

    What’s your advice? Should I buy the EFTs inside my RRSP, or in a TSFA, or in some other manner? I want to maximize their value till I actually stop working in 15-16 years.

    Thanks for your consideration!

  23. @Profile Investor: That’s what I do as well. I participate in the Employee Stock Purchase Plan (ESPP) offered by my US-based employer. Unfortunately though, the ESPP program has been cut back to just 5% of earnings. It used to be 12% before and at that time I just used the ESPP proceeds to buy US-listed stocks.

    @Flagen: Even though TD Waterhouse doesn’t have a separate US dollar RRSP account (what’s taking them so long?), it’s not a limitation. You can still hold VTI, VEA and VWO in your SDRSP account. Youmay have to “wash” your trades if you are buying and selling US-listed ETFs on different days.

    No, it’s not a typo. I looked at what happens after 50 years because that’s really my investment horizon when I started out.

    @Neophyte: It’s hard to answer this question in isolation (and BTW, nothing you read here should be construed as financial advice). You first need to consider how much you want in risky assets (which essentially means stocks) and how you are going to divvy up that between Canadian stocks and foreign stocks. Typically, an older investor has a significant allocation to bonds and bonds are best held in tax-deferred accounts. Will there be any room left after placing bonds in your RRSP and TFSA? IMO, you’ll need to look into these larger investment policy questions first.

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  28. With the new relatively cheap Canadian Vanguard etf’s I assume the advantage of buying the US list ETF’s has been reduced. In the coming months I plan to transfer out of mutual funds and set-up a couch potato fund but can’t decide which approach to follow. By the way I’m 34 years old so have time on my side.

  29. I am looking to purchase the Vanguard US Total Market Index ETF in my RRSP. I plan on holding it for another 12 years until I retire.
    Do I purchase the VUN (unhedged) or VUS (hedged)?
    Assuming (praying) oil will be back up to $80-90 by then I would think the CDN dollar will have appreciated from .83 where it now sits. Still, I am not clear if hedging will be of much benefit? Your thoughts, thanks.