Freedom 48 Investment Toolkit: Foreign Market Investment Basics

When investing your money, it’s important to diversify your investment into different types of assets (such as stocks, bonds and real estate), different segments of the stock market (such as financials, consumer staples, utilities, technologies, telecommunications, etc.) and different regions of the world (such as North America, Europe, Asia, etc.). However, for a small and insignificant Canadian retail investor like me, being able to do all of these will be quite challenging. First of all, direct access to international markets is very limited for retail investors. Secondly, having access to information and the knowledge to interpret that information on the international market (and foreign language) may proof to be too resource intensive and difficult for the average investor like me. Based on these two factors, I decided to stay within the Canadian and U.S. stock markets and only invest in the markets that I know. Since I am a Canadian, understanding the Canadian market is easy, but to venture into the U.S. market requires a bit of work. In this post, I will list some of the challenges that Canadian retail investors face when investing in the U.S. stock market. By overcoming some of these challenges, you’ll lower your investment risk, keep more of your money and improve your U.S. investment returns.

Foreign Market

Foreign Dividend Withholding Tax
When you (assuming that you are Canadian) invest in the U.S. stock market, you will be classified as a foreign investor based on U.S. laws. If any of your U.S. stock pays you a dividend, then the dividend will be subject to a foreign dividend withholding tax. This tax amounts to 30% of your total dividend, which really sucks when they take almost 1/3 of your dividend income. However, there is some good news to this as the Canadian and U.S. governments have a tax treaty, which would allow investors from both countries to pay less withholding taxes or no withholding taxes depending on which account the foreign stock is held. For Canadians, if your U.S. stocks are held in any retirement-related accounts such as RRSP, LIRA, RRIF or LIF, you don’t pay any withholding tax (you get to keep 100% of the dividend). If your U.S. stocks are held in non-retirement related accounts, you can fill out the “W-8BEN” form and have your investment brokerage submit it to the U.S. government on your behalf to lower the foreign dividend withholding tax from 30% to 15%. Furthermore, if you hold U.S. stocks in your non-registered account, you’ll get to claim a foreign dividend tax credit on your income tax. As for accounts like TFSA and RESP, the best case scenario is just getting the lower 15% foreign dividend withholding tax and nothing else.


Currency Risk And Hedging
When you invest in a foreign country, you’ll definitely have to convert some of your money from your country’s currency to the foreign country’s currency. For Canadians to convert our Loonie (CAD) to the Greenback (USD) or vice versa, the conversion cost is about 0.25% of the market rate, which is quite reasonable comparing to other currency pairs. To lower the currency risk, I use a few methods. The first method is to buy a U.S. index ETF such as the iShares S&P 500 Index Fund CAD Hedged (XSP) that holds U.S. stocks, but it’s priced in the Canadian dollar. This ETF will put in a USD to CAD hedge to make sure that the fluctuation in the currency market has minimal effect on the return of this ETF. So, on an annual basis, it costs this ETF about 0.25% to minimize the currency risk and the return of this ETF will almost mirror the S&P 500 Index. The second method that I use to lower my currency risk is to buy my U.S. stocks using my margin account. This way, I don’t convert any of my CAD funds to USD when I buy or sell my U.S. stocks and only the capital gain or loss portion of my U.S. stocks are subject to currency risk. The third way to lower my currency risk is to convert the currencies when the exchange rate is favourable from my perspective. For example, in 2011 when the CAD to USD exchange rate is $1 CAD to 1$.05 USD, I started to convert my CAD to USD. In early 2015, when the CAD started tanking, the USD to CAD exchange rate was about $1 USD to $1.25 CAD and I started to re-patriot some of my USD back to CAD. Let’s say that back in 2011, I converted $10,000 CAD to USD. So I got $10,500 USD after the conversion in 2011. Now forward to 2015, I converted my $10,500 USD back to CAD and got $13,125 (=$10,500*1.25). As a result of those opportunistic conversions, I made 31.25% (=[13,125-10,000]/10,000) in currency gains.


Increasing Your Income Tax Efficiency
If you have been reading my other posts, you’ll definitely come across the topic of income tax somewhere in those posts. So I don’t think this post will be complete if I don’t cover the income tax aspect of this investment strategy. First of all, the most efficient account to hold your highest dividend paying U.S. stocks is your retirement-related accounts (RRSP, LIRA, RRIF, LIF). When you hold U.S. stocks in there, you won’t be paying any foreign dividend withholding tax and the dividends and capital gains are taxed sheltered. The next best account to hold U.S. growth stocks is the non-registered account. Since growth stocks pay minimal to no dividends, you don’t have to worry too much about the withholding tax. In addition, you can use the margin account to lower your currency risk and convert your currency with more flexibility when the opportunity arises. The drawback for holding U.S. stocks in your non-registered account is the income tax treatment of dividends. Foreign dividends are being discriminated against and don’t get the same preferential tax treatment as Canadian dividends – they are being taxed as regular income. Lastly, the least efficient accounts to hold U.S. stocks are the TFSA and RESP accounts. Though they are registered accounts, they are not retirement related and the size and movement of funds in those accounts are quite restricted. It’s best to buy U.S. index ETF with currency hedges like XSP in those accounts.


My two cents
To ensure that my investments are well diversified and to reap the benefits that are tied directly to the economy of our closest neighbour to the south, investing in the U.S. stock market was a simple choice. However, with any investment en devour, there is always a level of risk and complexity that comes with it. To ensure that I put myself in the best position to succeed (and to make money), investigating and understanding the major risks and allocating my investments to the right vehicles and accounts will give me a head start. The ultimate key to any successful investment is to only invest in what you know.


So what is your approach to diversifying your investments?

Leo T. Ly, Canadian Personal Finance Blogger/Enthusiast and a Realtor Living in the Markam, Ontario, CanadaAbout Leo
I am a Canadian personal finance blogger/enthusiast and a Realtor living in Markham, Ontario, Canada. I built a net worth of a million dollars over a ten year period. I did it by being a disciplined saver, taking advantage of income tax rules and borrowing money to invest rather than for consumption. I am often excited to take advantage of free money from employers and governments in addition to building more passive income sources. After accumulating my first million dollars, I am now embarking on a second journey towards achieving financial independence. On this journey, I will strive to increase my net worth to two million dollars and retire by the age of 48 - Freedom 48. Come along and follow my journey on Facebook, Twitter, Pinterest or Google Plus.

There are 8 opinions expressed on this post.

  1. Currently in order to stay diversified I am buying passive index funds with exposure to both the US market and international markets. This ensures that I am not too concentrated in the US market and diversified enough that if the US or international market imploded I would be able to hopefully withstand the global turmoil. Although if the international or US market is imploding I’m sure it will affect one another.

    1. From what I see, ever since the 2008 Financial crisis, the global markets are very inter-connected and it’s no longer the case like when it’s 30 or 40 years ago where each region of the world is somewhat isolated. Now, you see that every region have global brands like Nike, Sam Sung, Honda, Google, Coke, Apple, Lenovo, HSBC, McDonald’s, ect.. So I think that diversifying into global markets may not be necessary if we have a portfolio of stocks that consist of global brands.

  2. Can you advise the tax implications for Canadians owning a rental property in US? My friend have talked about it and I’m wondering how much one gets to keep after being taxed.

    1. Hi 251-0-215,
      To answer your question there are two parts: the rental income and the capital gain. Based on the Canadian tax rule, your Canadian rental income is taxed at your regular tax rate. So chances are your US rental income will be taxed with the same rate as the Canadian rental income as I don’t think the Canadian government will provide preferential tax treatment for foreign investments over domestic investments. When you sell the property, you’ll have to pay capital gain tax on the money that you make adjusted based on the Canadian currency. If the value of you property that you own is over $100,000, you must fill out a form with the Canadian Revenue Agency to report that you own assets of over $100,000. I am not a qualified tax consultant, it’s best that you talk to an accountant to find out the options that best fits your personal situation. Hope this helps.

  3. One of the neat methods that I used to lower my foreign exchange fees or currency risk is to trade the dual listed stocks on the Canadian and U.S. stock exchange. For example, if I want to convert my USD to CAD, I just buy Agrium Inc. (AGU) on the NYSE and sell it on the TSE and settle the trade in CAD. Voila. My USD is now converted to CAD. The key thing to look for in the stock when you make this trade to ensure that there is no material news on the stock that day, the stock is highly liquid and there is no major news that affect the CAD/USD exchange rate.

  4. Thanks for the tip on the S&P 500 ETF. I was looking to invest in the U.S. Market but I don’t want to convert my money to USD. In hindsight, if I did, I would have made a decent return on the foreign currency gain.

    1. Hindsight is always 20/20, but we should not delve on the things that we didn’t do in the past. With that being said, there are always lessons to be learned and we hope to do better in the future. The only way to learn is to try.

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