6 min read Concepts

How to Invest in the US Stock Market (as a Canadian)

How to Invest in the US Stock Market (as a Canadian)

Learn why you should consider diversifying into US markets and how to access them without overpaying for currency conversion.

As investors, we tend to be home-country biased, meaning we typically invest mainly (or exclusively) in companies based in the country in which we live. This bias isn’t surprising, given the default options presented by our financial institutions tend to be heavily slanted in this direction. The problem is that the Canadian stock market has several limitations, especially compared to the US.

US Markets versus Canadian Markets

Economic Sector Diversification

Most of the highest-capitalized Canadian stocks skew towards financial services and commodities (e.g. more than half of TSX 60), which makes it more challenging to diversify effectively across economic sectors. There are a few larger companies in the other sectors (e.g. materials, high tech, consumer), but the choices are relatively limited. In comparison, the US markets are much bigger and more balanced across sectors, and far more options are available.

Geographic Diversification

When you invest primarily in companies based in your home country, your portfolio will be more correlated with the overall health of your country’s economy. For example, a recession will typically cause all of your investments to drop together. Investing outside of Canada will reduce this correlation, and companies in the US tend to have more global reach and, therefore, will be less reliant on the US (or Canadian) economy to thrive.

Liquidity

Of particular interest to those who like ETFs is that there is minimal choice for highly liquid Canadian-traded ETFs. For example, the top 10 biggest US ETFs trade an average of $920 million worth of shares per day. In Canada, the top 10 trade an average of $7 million per day—130× less. So, if you’re buying or selling a large position (e.g. switching assets), your trade could represent a meaningful percentage of that daily volume, leading to higher slippage and more timing risk.

Performance

Historically, the US economy and financial markets have grown faster than Canada. For example, the S&P 500 has outperformed the TSX over the past 80+ years by a couple of percentage points, even ignoring currency fluctuations.

Buying US Equities

All in all, it makes sense for most Canadian investors to have exposure to US markets. When first starting, buying a Canadian ETF (or mutual fund) that holds US equities (e.g. XSP, VFV, ZSP) is enough. Once your account is large enough (e.g. >$100K), it’s worth considering if investing directly in US dollars makes sense. The main reasons are that you’ll have more choices and lower fees—the Canadian funds holding US dollar assets have much higher management fees than holding them directly yourself.

Opening a US dollar account at your bank or brokerage is relatively easy. The problem is that they charge a premium (I’d argue unreasonably large premium) on currency conversions of 1.5%–2.5%. So, to convert $100K, you’re paying $2K. If you’re trying to earn 8% a year on that money, you’ve already lost a quarter of your potential returns for the first year.

Currency Conversion

Meet Norbert

Fortunately, there’s a straightforward method for skipping these significant currency conversion costs when investing. Norbert’s Gambit is named after Norbert Schlenker, who published this technique in 2001. However, since banks have not yet lowered their currency conversion fees, it appears that most investors are not taking advantage.

The process is simple—you need access to an asset that is dual-listed in (trades in both) Canadian and US dollars and can request that it be journaled (transferred) between accounts. The most commonly used asset with Norbert’s Gambit is Horizon US Dollar Currency ETF (symbols DLR & DLR-U). There are several other choices, but most are actively traded companies. And since you will probably need to hold the shares for a couple of days (long enough for the trade to settle), you’re introducing some minor timing risk from those companies’ usual daily market fluctuations. Therefore, I prefer DLR since it only tends to move in response to the exchange rate and is sufficiently liquid for most DIY investors.

Main Steps

To convert from Canadian $ to US $:

  1. In your Canadian $ account, buy shares of DLR worth the amount (in Canadian $) you want to convert.
  2. Have your financial institution journal your shares of DLR from your Canadian $ account to your US $ account as DLR-U.
  3. In your US $ account, sell the shares of DLR-U.

To convert from US $ to Canadian $:

  1. In your US $ account, buy shares of DLR-U worth the amount (in US $) you want to convert.
  2. Have your financial institution journal your shares of DLR-U from your US $ account to your Canadian $ account as DLR.
  3. In your Canadian $ account, sell the shares of DLR.

What is Journaling?

Journaling (step 2) is probably not something you’ve heard of before. It’s an administrative transfer, performed by your broker, of logically equivalent assets between accounts. For example, 100 shares of DLR and 100 shares of DLR-U represent identical amounts of the same underlying asset, with one denominated in Canadian dollars and the other in US dollars.

Journaling is a standard action that brokers perform for many different reasons. So, you won’t confuse or surprise them with your request, nor will they question it.

How Much Does It Cost?

Steps 1 and 3 are standard trades, so you’ll be charged your standard transaction fee. For example, if you pay $9.99 a trade, this process will cost you ~$20, which makes the breakeven point converting $1,000. If you’re converting less, you might as well pay the standard 2% conversion fee. The benefit of this strategy is your costs are fixed, regardless of whether you’re converting $1,000 or $1,000,000.

There is no cost for journaling (step 2).

How Long Does It Take?

It depends on your brokerage. The longest part is usually waiting for the trades to settle. If you must wait for the trade in step 1 to settle before requesting the journal, it will take a few days from start to finish. If you want to withdraw cash (rather than invest it), you’ll also need to wait for the trade in step 3 to settle.

In Practice

The challenge is that every brokerage has slightly different rules for executing these steps. To find detailed instructions and potential surprises related to your specific broker, do an internet search for Norbert’s Gambit + the name of your financial institution.

Here are the key points to understand regardless of financial institution:

  • Many brokerages require you to call them to journal your shares, typically after your initial trade (step 1) settles (a day or two).
  • When you call them, they’ll usually ask if you want to sell the journaled share immediately (in step 3). If you say yes, they’ll create manual entries in your account in real time, and you can sell while you’re still on the phone. Otherwise, the journaled shares will take a few days to transfer.
  • Some brokerages don’t require you to call them to journal (like RBC)—you simply enter both trades at the same time (e.g. buy X shares of DLR in your Canadian $ account and sell X shares DLR-U in your US $ account). They’ll automatically journal the shares for you during settlement, offsetting the two trades. Note that when you enter the sell order, it will warn you that you may not have enough shares to cover the trade—because technically, you don’t yet.
  • Some brokerages (like TD Direct) will let you transfer (i.e. journal) shares online between accounts through their website.
  • Some brokerages don’t support journaling (like Wealthsimple), which is unsurprising since they have no transaction fees and need to make money in other ways. If you have one, you can convert your cash to US $ at a different institution and transfer it over.

I’ve used this technique successfully many times at different institutions. Once you’ve performed it once, it’s easy to repeat.

Tax Implications

One other unappreciated note about investing in the US is there are differences in the way dividends are taxed, depending on the type of account where you hold your investments:

  • Unsheltered trading account — Dividends from most Canadian corporations are eligible for the dividend tax credit, significantly reducing the tax you’ll owe on those dividends. Foreign dividends do not have this benefit and will be taxed higher.
  • TFSA, RESP, and FHSA — These tax-sheltered accounts eliminate taxes due on capital gains and distributions. Unfortunately, the US government does not recognize them for tax purposes relative to dividends. As such, US dividends will get taxed (15%) at the source (before you receive them), and there is no way to recover these taxes.
  • RRSP — Unlike the other tax-sheltered accounts, RRSPs are recognized by the US government for tax purposes. Therefore, your US dividends will not be reduced by taxes, making RRSPs the most tax-efficient place to hold US dividend-paying stocks.
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Key Points

  • As a Canadian, investing in US markets has several benefits worth exploring (choice, diversification, liquidity, performance).
  • As a self-directed investor, you can bypass the hefty premium (2%) banks charge on currency conversions by executing offsetting trades in a dual-listed equity. Search for Norbert’s Gambit for detailed instructions for your specific financial institution.
  • Taxes will reduce dividends from US companies in TFSA, RESP, and FHSA accounts but not your RRSP. In unsheltered accounts, US dividends aren’t as tax-advantaged as Canadian dividends.

Points to Ponder

  • Have you considered diversifying into US and international markets? Why not?
  • Are you willing to do a little more work to bypass the high fees charged by your bank if you could save thousands of dollars?
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