So many things go into deciding which investments to make, and when you are deciding on whether it is worth buying US Stocks in Canada there are several things that you should be aware of.
Buying US Stocks as a Canadian is a great way to diversify your portfolio and can add a significant source of income but other factors need to be considered such as; fluctuations in Foreign Exchange Rates, Currency Conversion Costs, US Withholding Tax, and US Estate Tax when you die.
Each factor is something that needs to be explored and considered before making any big investments outside of Canada. Although some factors may not be a concern to you at the moment, knowing that future situations can change makes your plan for investing in foreign countries very important.
- Diversification
- Foreign Exchange Rate Fluctuations
- Currency Conversion Costs
- US Withholding Tax On Dividends
- US Estate Tax Filing Over $60,000
Diversification
As a whole, if you are only investing in the TSX (Canadian Stock Market) you are naturally limiting yourself to how diversified your portfolio is. The S&P/TSX Index (INDEXTSI: OSPTX) is made up of 11 sectors all weighted individually and represents the overall TSX market.
The 11 sectors included in the Index are the financial sector, energy, materials, industrials, consumer discretionary, telecommunication services, healthcare, consumer staples, utilities, information technology, and real estate.
Out of these 11 sectors included in the S&P/TSX Composite Index, the 4 largest sectors are; Financial 28.6%, Materials 14.1%, Energy 13.5%, and Industrial 11.7%.
This means the top 4 largest sectors in the Canadian Stock Market are representing 67.9% of the overall market!
With the top 4 out of 11 sectors representing so much of the overall Canadian Market, (67.9%) If something unfavorable takes place in the Canadian economy (even temporary) it can have a very destructive effect on your portfolio.
When you invest in the US Stock Market (NASDAQ, NYSE) through investments such as the S&P 500 or DOW JONES you will get exposure to separate markets that can spread out your investments and lower your Investment Risk.
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The main strategy of having a diversified portfolio is that one security doesn’t represent too much of your portfolio. In the TSX with the top 4 representing 67.9%, you are potentially exposing yourself to slightly more risk.
For example, let’s assume you have a portfolio of $100,000.
If your portfolio is only invested in the TSX Index encompassing the Canadian economy and something happens to the top 4 sectors. 67.9% of your portfolio will be affected by the event, whereas if you are diversified outside ofJUSTthe TSX less of your portfolio will be affected.
To show in a Table, there are two portfolios, one is only in the TSX (Canadian) and the other has a 20% investment in US Markets.
In this scenario, the top 4 markets in the TSX will be affected by “An Event” that will lose 15% of the value. You can see that by diversifying out of just the TSX your portfolio will be less affected by the 15% loss.
| $100,000 portfolio | Only Invested In The TSX | With 20 % Invested In US Markets |
| 67.9% (Top 4 Sectors) | $67,900 | $54,320 |
| 15% loss | $57,715 | $46,172 |
| total loss | $10,185 | $8,148 |
| Difference | $2,037 |
By having 20% of your portfolio Diversified outside of the Canadian Markets in this scenario you will have suffered less of a loss ($2,037) than being just invested in the Canadian Markets.
A study doneby Joost Driessen and Luc Laeven in Dec 2004 concluded that there are strong advantages in diversifying your portfolio to even a global scale.
We have investigated for a sample of 52 countries how the benefits of international portfolio diversification differ across countries from the perspective of a local investor. Our main findings are as follows. First, we show that there are substantial regional and global diversification benefits for domestic investors in both developed and developing countries, even under the realistic assumption that investors cannot short sell stocks in developing countries.
(Driessen is at the University of Amsterdam. Laeven is at the World Bank and CEPR)
Foreign Exchange Rate Fluctuations
Foreign Exchange Rates becomes a factor when investing in another country. Some investors take advantage of the fluctuations in exchange rates of currency, commonly known as FOREX Trading.
The overall change in exchange rates can work IN your favor but can also work AGAINST your investments and affect your overall returns. This is because when you are invested in another currency such as US dollars, you purchase these investments with US dollars.
You will have to exchange your Canadian dollars for US dollars and then you can purchase the security. Right now the Exchange rate from Canadian to US dollars is; $1 Canadian is equal to $0.76 US or $1 US is equal to $1.31 Canadian.
What this means for you as an investor is that to purchase a Security with a Share Price of $85 US it will cost $111.09 Canadian. (right now): current rates
Now this cost will fluctuate over time increasing and decreasing, which is how you can be affected. If you were to purchase 45 of those US Shares for $85 per share it would cost you $3,825 US.
After the currency exchange (assuming no exchange costs) it would cost $5,010.75 Canadian. Now, if the exchange rate changes you can gain value but also lose value as shown.
| % Change | Exchange Rate | US Cost (45 Shares at $85) | Canadian Cost |
| #1 (Control) | $1.31 | $3,825 | $5,010.75 |
| #2 (-6) | $1.25 | $3,825 | $4,781.25 |
| #3 (-16) | $1.15 | $3,825 | $4,398.75 |
| #4 (+14) | $1.45 | $3,825 | $5,546.25 |
| #5 (+7) | $1.38 | $3,825 | $5,278.50 |
Now, to explain what is happening here, #1 is our scenario. You purchase the 45 shares which cost $5,010.75 Canadian.
In Scenario #2 and #3 the exchange rate decreases. (Canadian Dollar increased in value) This would be a good thing if you hadn’t purchased the Shares yet but because you already have, your investment value in Canadian Dollars has “gone down.”
If you were to sell the Shares (45 at $85) you would still receive $3,825 US but when you exchange that for Canadian Dollars you will only end up with $4,781.25 ($1.25 exchange) or $4,398.75 ($1.15 exchange) respectively.
In scenarios #4 and #5 the exchange rate increases (costs more per dollar) which in turn “makes you money.”
By investing your money outside of Canada you are exposing your money to other factors such as Foreign Exchange rates which will add more complexity to your investments.
Currency Conversion Costs
Fees, Fees everywhere, this is how it seems these days, and buying securities outside of Canada is no different. There are Fees associated with converting or exchanging currency.
You need to pay attention and understand that currency exchange can add up to a lot of money. The typical “spread,” which is the difference between the exchange rate and the cost to exchange the currency can vary from 1-3% per transaction.
Yes, this means when you go to exchange $1,000 Canadian you will lose between 1-3% in exchange Fees. (Conversion Costs)
Then if you sell the securities you held in the US and want to convert it BACK into Canadian Dollars you will have Conversion Fees again!
Here are some examples of how much it can cost to exchange your money back and forth from Canadian to US.
To get $1,000 US with an exchange rate of 1.31 you will need $1,310 but if you have a Spread of 2% it will cost you, $1,336.20. That’s a difference of $26.20, which may not seem like much but it goes directly against your buying power in US currency.
Then, if you want to convert your $1,000 US back into Canadian you will need to pay those fees again!
Sometimes it can be better to slowly exchange or purchase US securities in a US brokerage account. You can transfer money from your Canadian account through and then keep it in US Dollars If you sell the security.
This can lower Conversion Costs and help you keep more buying power for your investments.
US Withholding Tax On Dividends
Are you a dividend investor? Would you like for your investments to pay you a couple of times a year? Well, that’s exactly what dividend-paying securities can do!
You can get several times a year rather than just relying on the stock price to increase and getting Capital Gains from the sale of the Security. But, there’s a slight catch you should know about.
The US only recognizes certain Canadian investment accounts as tax-free! If you are investing in US Securities through a TFSA you will have a Withholding Tax on your Dividends.
The US IRA will withhold a minimum of 15% of dividends paid by US companies to Canadian Residents when Invested with a non-registered investment account. Therefore, Dividends from a US Company paid to you through an RRSP or RRIF will NOT be subject to Withholding Tax by the IRS.
But, if you are investing through your TFSA or an RESP the IRS will withhold a minimum of 15% of your dividends as these accounts are viewed as foreign trusts.
As well as being subject to Withholding Tax by the IRS, Dividends paid by foreign companies do not qualify for the Dividend Tax Credit and are taxed in the same manner as Interest.
This can have big implications on your tax returns depending on how you are purchasing these securities and HOW MUCH you are spending on foreign investments.
US Estate Tax Filing Over $60,000
Even when you die, having foreign investments can complicate things for the ones you leave behind. As of right now, if you have $60,000 or more invested in US Assets when you die your estate will need to file a US Estate Tax Return within 9 months even if you don’t have any tax obligations.
Some of the Assets included are; US Securities (Shares), US Real Estate, or Business Assets.
It’s not all bad though, Canada’s Tax Treaty with the US allows you to reduce your Estate Tax Liability by applying for a Tax Credit.
You don’t ALWAYS have to pay taxes.
U.S. stocks are not always subject to U.S. estate tax: Canada – U.S. Tax Treaty
Canadians are protected by Article XXIX B (8) of the Canada – U.S. Tax Treaty which provides that:
If at the time of death, the entire worldwide estate of a Canadian resident (other than a U.S. citizen) does not exceed $1.2 million US, the U.S. will only impose estate tax on property for which, on disposal by the owner, any gain would have been subject toincometaxation by the U.S. This includes:
- American real estatePersonal property which is part of the business property of a permanent establishment or fixed base in the U.S.
This means that shares in U.S. corporations would not be subject to U.S. estate tax when the entire worldwide estate of the Canadian resident does not exceed $1.2 million US.
Another thing to note is if you have US securities owned through a Canadian Corporation you will not be subject to the Estate Tax because the securities are considered to be owned by the Corporation, not the Individual. This can help you protect your investments and lower your potential tax burden.
Conclusion
Although many things are affecting your investments when you are investing in the US, It can still be very beneficial for you to consider. Talk with your financial advisor(s) and come up with a good plan that will help protect you from the many things that can affect your money.
Knowing how to use investment income to further and accelerate your gains is the key to long term success when investing!
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