Brokerage firms
Canadian investors need to be especially observant of their broker fees. In my opinion, 90% of do it yourself investors could tell your what their commissions are but only 10% could tell you what their spread on foreign currency transactions is. For most discount brokerages (Qtrade, Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) direct invest etc.) it ranges from 1-1.5%. It doesn’t sound like much but if you don’t have a US dollar account and you keep settling US trades in Canadian dollars you are putting yourself at a massive disadvantage.
For example, say you have a $100,000 you want to transfer. You first lose $1,500 for the initial transaction but then if you settle back in Canadian dollars you lose an additional $1,500, for total costs excluding commissions of 3%. That’s like starting a hundred metre race 3 metres back, good luck beating the competition.
One way investor’s can reduce this annoyance is through having a US dollar account. These are available at Canadian brokerages too. However, you are still left with the initial US dollar conversion. Thankfully there is a technique called “Norbert’s gambit” where an investor takes advantage of dual listed shares (eg. Research In Motion Limited (NASDAQ:RIMM), General Motors Company (NYSE:GM) etc.) as a way of converting currency without the substantial cost.
For example, buy Research In Motion Limited (NASDAQ:RIMM) in Toronto with Canadian dollars, transfer the holdings with your broker to your US account and sell Research In Motion Limited (NASDAQ:RIMM) in the New York for US dollars.
You used to be exposed to holding the underlying stock while the trades settled. Thus, unless you were hedging the transaction, any fall in RIM would reduce your value.
However, as pointed out by money sense magazine, there is a now a Horizon US DOLLAR ETF which trades in both Canadian and US dollars. So there is no risk of the underlying investment changing as it’s cash although you do have be away from the market while your trades settle. The bid and ask spreads are only a penny. If you don’t have commission-free ETFs, add in your commission to this example but it would still save you money.
Example: You want to convert $100,000 Canadian in to US dollars.
Buy 10,204 (TSX:DLR) shares @ the ask price of $9.80 for a cost of CDN $99,999.20
Transfer them to your US account.
Sell the 10,204 shares in US dollars (TSX:DLR.U) @ the bid price of US$9.91 for proceeds of USD$101,121.64
This creates an exchange rate of $1.0112 vs the market rate of $1.0131 for a cost of 19 basis points or .19% vs the broker’s rate of 1.5%
Total cost per $100,000: $188.36 vs the broker’s cost $1,500.