Happy New Year 2016! Let's discuss Currency and Foreign Investments

Date: January 6, 2016 Author: juneinc Categories: Latest
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How currency impacts your return

When you invest in a foreign investment (i.e. US stock or global mutual fund), the return you receive in Canadian dollars is positively or negatively impacted by how your home currency (in this case Canadian dollars) moves against the foreign investment's currency.

For example in 2015, one Canadian dollar bought 85 US cents on January 1st.  By December 31st it only bought 72 US cents.  Therefore the Canadian dollar had depreciated by 15% (85 less 72 divided by 85) - which in turn means US dollar investments for Canadian investors appreciated by at least 15% represented by the currency move.  Let's pretend you bought one American stock for $100 US dollars in January.  If the stock was worth $110 US dollars by December, your return in US dollars would have been 10% and in Canadian dollars your return would have been 25% (the investment return of 10% plus the currency return of 15%).   While a Canadian investment that returned 10% in 2015 would represent 10% for a Canadian investor.

Now if you are Canadian, imagine if you were an American investor.  If an American bought a Canadian stock that returned 10% in Canadian dollars, the investor’s return in US dollars, which is what matters to an American, would have been actually minus 5% (10% investment return less 15% currency depreciation).  For Americans, the Canadian stock market has been on a steady decline since 2013 – in US dollars.

The pattern of the Canadian dollar

The Canadian dollar trades with the price of oil and since the price of oil has declined over the past few years, so has the Canadian dollar against the US dollar. 

Over a long period of time, currency goes up and down, and works itself out to neutral impact on your returns - over the long term.  However, over the short term, it can have a significant impact.  Many Canadians have been fooled by American investment returns - believing they are better than they have actually been due to the currency impact.  And similarly, many Americans have sold Canadian investments due to the short term currency impact.  For example, since 2013 to today, the TSX (Canadian stock market index) in US dollars has lost 26% - that is what an American would feel.  While the TSX has risen 6% in Canadian dollars – which is what a Canadian would feel.  Quite a difference!

Another interesting thing about currency is that many only think about currency versus the US dollar.  However, if you are invested globally, as is recommended, you will have positive and negative currency impacts across the globe.  For example, over the past 10 years, the Canadian dollar has depreciated against both the US dollar and the Japanese Yen by 15% while the exchange rate between the Euro and the Canadian dollar has not really changed over the past ten years. 

Thus when you are investing, be diversified in Canadian, American and international (non-North American) investments and do not worry about short term currency fluctuations.  However, do be aware of them so you know how your investments are really doing in their home currency. 

This following chart shows the Canadian dollar against the US dollar over 30 years.  You'll see it begins and ends at the same level with dramatic changes in-between.  Patience is again a virtue!  Be diversified between the Canadian dollar (~50%), the US dollar (~25%) and other currencies (~25%) to protect yourself from undue short term fluctuations.