Is Now The Time to Convert USD to CAD?

The USD/CAD exchange rate has been hovering around the 1.4 mark since the end of March.  This means that for every $1.00 US dollar you convert to Canadian dollars, you’d end up with $1.40 Canadian dollars in your pocket. Looking at historical data from September 2003 to the present, there was only a short blip in January 2016 where we saw the exchange rate rival this figure for a week and then it went back down below 1.40 and it has remained in the 1.30-1.35 range for years.  Now, I am by no means a foreign exchange rate expert by any means, but it is something I pay attention to since I am dealing in both US dollars and Canadian dollars for our portfolio.

A Look Back In Time

From the late 1990s to the early 2000s the exchange rate had reached it’s highest point during my lifetime peaking at 1.60 in February 2002.  For almost 4 years, from January 2003 until October 2007, the exchange rate gradually narrowed down to 1:1 par during the 2007-2008 financial crisis and slowly plummeted to its low of 0.94 in October 2007.  There were a couple of months where the Canadian dollar was stronger than the US dollar.  During the Great Recession, the US market took a beating while the Canadian market didn’t take as big of a nosedive.

This recession was mainly due to subprime mortgages in the US. The Canadian real estate market did not suffer nearly as many foreclosures or short sales during this time. In 2009 the exchange rate jumped up to the 1.25 range but then came back down to the 1.00 range by the end of 2009 where it remained through 2013.  For the most part, from late 2007 until the end of 2013 the USD/CAD exchange rate was generally close to 1.0.  This illustrates the US’s struggle during the years of the Great Recession.

2014 saw a slight climb to 1.10 and by 2015 it had continued upwards in the 1.20 range as the US continued to recover and grow.  I remember this time frame vividly as we were living in Florida, engaged, and planning our Canadian destination wedding in the summer of 2015 (which we kept under $9,000 CAD/$7,000 USD for 90+ people, I suppose we should write a future post on this eh?).  When we saw the exchange rate reach 1.20 we jumped for joy to lock in various wedding expenses as we were now getting a 20% discount by paying with our USD greenbacks.  Ohhh yea!  I remember chatting with the gentleman who organized the hall we rented out about this and he chuckled “no need to rush, it’s not going anywhere”.

And boy was he right.  Oil prices tanked and because Canada is very heavily focused on natural resources, mainly oil & gas (Canada is the world’s fourth-largest oil-producing country behind the US, Saudi Arabia, and Russia), the CAD took a beating as the exchange rate reached its tipping point of 1.45 on January 18, 2016.  As oil prices plateaued we saw the exchange rate back down into the 1.30-1.35 ever since that point in 2016.

Until Coronavirus that is.

On March 20, 2020, we saw the USD/CAD exchange rate hit the 1.45 mark again and it’s been hovering in the 1.39-1.42 range ever since.  Unlike the 2016 blip that lasted less than 1 week, we’ve seen these rates sustained for over 2 months now.

Is This The Best Time to Convert USD to CAD?

The short answer is, no one knows.  Seeing the Canadian dollar lose ~10% of its value since the beginning of March makes a valid case that now is a good time to convert. But will it trend towards even more favorable conditions?

As we all know, there are a lot of unknowns taking place in the world these days thanks to the outbreak of coronavirus.  Central banks, including the Bank of Canada and the Federal Reserve, took note of the pandemic and adopted dovish monetary policies to help support their economies.  The impact of COVID-19 on global economies is a long way from being over.  Are we on the mend or will there be a resurgence later this year?

The Saudi Arabian/Russian oil talks deteriorated into an all-out pricing war, leading to a 60% drop in West Texas Intermediate (WTI) prices in less than a month.  Again, because Canada is heavily dependent on its natural resources, this took a toll on the value of the Canadian dollar.  We saw gas prices at the pump of $0.59/l ($1.73/gallon) for regular unleaded gasoline back in April which is pretty unheard of in our part of the world. For reference, the April 2020 average price for regular unleaded gasoline in Calgary averaged $0.662/l ($1.91/gallon) which is the lowest monthly average since February 2004.  It’s since moved to $0.79/l ($2.30/gallon) and it recently jumped to $0.92/l ($2.68/gallon) which just under the $1.00/l ($2.89/gallon) we’ve been averaging the past year.  Is this bump at the pump a sign that the Canadian dollar may increase in value?

The combo of COVID-19 and the steep drop in oil prices was a double whammy for Canada. Is the steep Canadian dollar devaluation over the past few months an anomaly?  A 10% devaluation in such a short time is unheard of in the past 20 years, which makes the case for selling US dollars more compelling.  Again, time will ultimately tell, but to me, it seems like a good time to shift over some of our USD to CAD.

The Role of The US Dollar

So why is the US dollar holding up so strongly right now?  Investor Warren Buffett summed up the situation very concisely at his annual meeting: “You can finance a deficit as long as your currency holds up.”  It’s about debt sustainability.  With 10-year Treasury yields at about 0.68% and 30-year yields at 1.30%, the US can sustain high debt for a long time—unless investors lose confidence in US policy.

Despite fears of inflation and “money printing”, the US dollar has remained strong.  There are few signs that investors are losing confidence. Because currencies are measured in relative terms, the dollar benefits from a lack of good alternatives.

More importantly, the world’s financial system is more dependent on it than ever.  The vast majority of global transactions take place in US dollars. Central banks around the world hold US dollars.

At some point, investors could lose confidence in the US and shift out of dollars.  The administration has made it clear it wants a weaker dollar for trade purposes.  However, in the current environment, it’s hard to see what will replace it as a safe haven or a means of transactions any time soon.

Why Do We Care?

Anyone that has been following along with our Quarterly Net Worth Updates knows that about 70-75% of our passive income is in USD as I worked in the US for the majority of my career, of which some of that is in cash.  In our FIRE calculations, we assume a USD/CAD exchange rate of 1.30 which is part of how we go from a 4% withdrawal rate closer to a 3% withdrawal.  This is obviously a variable factor to our FIRE calculations that is ultimately out of our control.  Locking in an exchange rate above 1.30 seems to be a win in my books.

Seeing the exchange rate where it’s at, we’ve been converting some of our USD cash over to CAD cash to then funnel various Canadian accounts.  So far, we’ve shifted ~$14,000 USD to $19,500 CAD (as of May 26th) with the plan to shuffle another ~$7,000 USD to ~$10,000 CAD to top up our tax-advantaged accounts (Nic’s TFSA and Spousal RRSP) to their max contribution limits.

For anyone curious, we use our Charles Schwab checking account which comes with unlimited ATM rebates (aka no ATM fees) worldwide.  This is our go-to card recommendation to any US travelers out there.  We simply fund USD into this account, go to any ATM, withdraw $1,000 CAD (the max allowable in a day), receive the exchange rate with no hidden extra fees or surcharges attached, deposit this same $1,000 CAD back into our Canadian bank account, and lock in the exchange rate conversion. Note, we could do a one-time international wire transfer for $25 but we wanted to ask the audience a question before we go this route. For Canadians without this option, Norbert’s Gambit is another route to convert currency.

Our Question For You

We know there are some savvy readers out there and we have a question for you.  It seems like a no brainer for us to convert USD to CAD, lock in the 1.40 exchange rate, and fund our tax-advantaged accounts for the year. (Unless someone who has more knowledge in this field would like to share with little ole us?)  The question we have is in regard to exchanging USD to fund our non-registered (aka brokerage aka taxable) Canadian accounts.

Would you rather:

1.  Keep the currency in USD, invest in VTSAX (index fund tracking the overall US stock market) in a taxable US brokerage account, pay an expense ratio of 0.04%, withdraw from this account years out in the future and convert to CAD based on whatever the USD/CAD exchange rate is at that time? OR
2. Convert the USD to CAD locking in the ~1.40 exchange rate, invest in VUN.TO (the Canadian equivalent to VTSAX being held in CAD instead of USD) in a taxable Canadian brokerage account, pay a management expense ratio (MER) of 0.16%, get hit an additional 15% withholding tax for holding US funds outside of the US, and not have to worry about currency risk down the road?

The pro of option 1 is there are lower fees involved but you’re exposed to currency risk (which may or may not be a bad thing).  The pro of option 2 is locking in the 1.40 exchange rate but you’re getting hit with extra fees that the US imposes for investing outside their country.

Let’s take a look at an example using $20,000 USD assuming 8% growth over a 20 year period.

Option 1:

• No conversion so the initial investment is $20,000 USD
• Assume net growth of 7.96% (8.00-0.04 fees)
• After 20 years, you’ll have $97,756 USD
• If you assume the USD/CAD exchange rate at that time is 1.30, you’ll end up with $127,082 CAD

Option 2:

• Convert $20,000 USD to $28,000 CAD at the current 1.40 exchange rate
• Assume net growth of 7.69% (8.00-0.16 MER-0.15 US withholding tax)
  • Note this isn’t exactly how the withholding tax works but it’s the simplest way to play with these calculations
• After 20 years, you’ll have $129,709 CAD

Essentially you’re playing a guessing game with the future of the USD/CAD exchange rate (assuming the fees remain the same over time).  If you think the exchange rate will be lower than 1.30 in the future, it makes sense to do the conversion now.  If you expect the USD/CAD exchange rate to be higher than 1.30 in the future, it makes sense to keep the funds in US dollars.

But wait, there’s more.

The 3rd option that we’ve come up with is to focus on international index funds vs US index funds.  Similar to option 1 above, we could choose to keep the money in USD and invest in VEU (All-World ex-US ETF), which comes with a 0.08% expense ratio, or VTIAX (Vanguard Total International Stock Index Fund), which comes with a 0.11% expense ratio, in our US taxable account.

Or, option 4, we could convert to CAD but rather than invest in VUN.TO, instead invest in VDU.TO (Developed All Cap Ex-US Index Fund) which comes with an MER of 0.22% but no 0.15% US withholding tax since this an ex-US index.  This can be a good way to lock in the exchange rate and add more diversification to our portfolio since we are currently sub 10% international.

The main question here is the unknown of if US stocks will outperform international stocks?  There are many arguments to be made for both sides.  After reading more and more articles/books I feel like I should be diversifying more.

Let’s take a further look when comparing fees assuming the same 8% annual growth and a 1.30 USD/CAD exchange rate at the time of withdrawal:

Option 3:

• No conversion so the initial investment is $20,000 USD
• Assume net growth of 7.92% (8.00-0.08 fees) – using VEU since it is a lower fee compared to VTIAX
• After 20 years, you’ll have $96,982 USD
• If you assume the USD/CAD exchange rate at that time is 1.30, you’ll end up with $126,076 CAD

Option 4:

• Convert $20,000 USD to $28,000 CAD at the current 1.40 exchange rate
• Assume net growth of 7.78% (8.00-0.22 MER)
• After 20 years, you’ll have $132,050 CAD

In this scenario, doing the conversion now at 1.40 makes you $6,000 richer 20 years down the road.  Again, the big question/unknown is will the US outperform the rest of the world or vice versa? Who knows.

The last thought, Option 5, is to convert to CAD and invest in Canadian stocks where we would receive the Canadian dividend tax credit by investing in Canadian dividend producing stocks in our taxable Canadian account. While this strategy does have some perks and most Canadians reading would likely suggest going this route, we personally do not plan to invest this way.

Why not? Short answer: home country investing bias.  Canada makes up less than 2% of global GDP and it is very heavily focused on banks and natural resources – two industries I personally do not want to be too heavily invested in.  We also plan to withdraw a relatively low amount each year that we aren’t going to be in a high tax bracket down the road (assuming the current setup) so this tax credit will be of little benefit for us. Can anyone convince us otherwise?

Final Thoughts

We’re leaning towards doing the conversion now with some of our excess US cash since we live in Canada, spend in Canadian dollars, and have no plans to leave Canada (thank you Canada for being an early retirees dream country).  I’m torn about investing in US vs international.  The logical side says I should have more international exposure but the numbers side says the US index has been the clear winner in the recent past (of course, we all must realize and remember that past results are not equivalent to future projections). However, the US vs the world tends to be cyclical and maybe it’s time for the world to strike back?

Some could also argue that it’s only a matter of time before US dominance as the world’s superpower is up. Will it happen during my lifetime? Who knows.

We would love to hear any thoughts or comments you have!  What are your thoughts on the exchange rate?  Would you convert now or hold off?  Would you invest in US or international funds?  Which option above would you do and why?

Note: Literally yesterday (May 27, 2020) we saw the exchange rate drop from 1.40 to 1.37 so maybe this all it a mute subject if the exchange rate continues to tumble back to the 1.30 range?

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• Investing Newbies: Check out our free Investing 101 Series.
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