Here is a 10 year graph of the same investment, the S&P 500, being held in Canadian dollars and being held in US dollars.
Because of the cost of hedging, the investments in Canadian dollars under performs the investment in US dollar by a whooping 15.60%, that’s a lot of moolah.
Long ago I suggested that the ideal portfolio for a Canadian would be composed of ⅓ Canadian index stocks, ⅓ US index stocks, and ⅓ international Index stocks.
Now the question is: In which currency should you hold those investments which are not in Canadian dollars?
The way I have decided to do it is by investing my ⅓ of US index in US dollars.
I would have considered investing the ⅓ of international in foreign currency but it is just too complicated. I would have to deal with Euros, Yens, Yuans, and all the other currencies of the emerging market. My portfolio in not big enough to burden myself with all those details.
On the other hand, my US investment is ⅓ of my portfolio, that is quite substantial. So the question is valid. Should I invest my US portion in Canadian dollars or in US dollars.
Many of you may be unaware that there is such an option.
When we buy the most popular US index, the S&P 500, we have the option to buy it with US dollars or in Canadian dollars. The S&P in Canadian dollars is protected against the currency fluctuation of the Canadian dollar vs. the US dollar. But that protection comes at a price. It is like paying for home insurance, it’s not for free. This hedging cost is about 0.15% of your US assets. Not a lot, but it’s just another erosion of your capital.
If you are investing for a short term period, you should not be investing in the stock market.
If you are investing for a long term goal, then you are further diversifying your portfolio not only by investing in the US market but also investing in the US dollar.
As Canadians, we have to be aware that our currency fluctuates a lot with the price of oil. We think that Canada is an advanced economy, but we are nothing more than a big gas station for the rest of the world. If oil prices go up, our currency goes up, If oil prices go down our currency goes down. Our currency is in fact too volatile and the US dollar is the more stable currency; their economy is more diverse.
Looking it from that point of view it makes sense to have some of our money in US.
In regards to cost, how does it compare.
When I keep my US investment in Canadian dollar I have to pay the hedging cost every year, this hedging erodes my returns over time.
When I keep my US investment in US Dollar, since I earn in Canadian dollar, I have to pay the conversion cost from Canadian to US and then when I retire, from US to Canadian.
In the long run, I feel that keeping my US investments in US dollars is less expensive and I feel more diversified.