The Canadian’s Guide to U.S. Investing
Here at Investment U, we tend to focus on American stocks. But we know that many of our readers are buying them in Canadian dollars – not greenbacks.
Perhaps we’ve been a bit neglectful of investors from the Great White North. Today, we hope to remedy that with an FAQ article for our Canadian readers.
We recently reached out to Eric Roseman, president and CIO of the Montreal-based asset management firm ENR, with some common questions about buying American stocks from the other side of the Great Lakes. You can read his answers below.
Can Canadian investors buy U.S. securities directly? Are there any accreditations or permissions required?
Provided these securities trade on a U.S. exchange, there are no restrictions. Canadians can also purchase units of a U.S. limited partnership with no restrictions from a Canadian tax perspective.
Should Canadian investors have exposure to U.S. equities?
Considering Canada represents just 3% of the world’s stock market capitalization (according to Morgan Stanley Capital International), it would be wise and profitable for Canadians to diversify outside of their home domicile.
The United States represents 60% of the MSCI World Index; therefore, Canadians should maintain a sizable allocation to U.S. stocks for long-term capital growth and income. The Canadian market is heavily weighted by natural resources and financials; the U.S. broader market is far more diversified and provides greater domestic and international exposure.
Forty percent of the S&P 500’s earnings are derived from overseas markets. In contrast, the Canadian stock market is far more insular and not as diversified.
For Canadians, are there tax implications to investing in U.S. stocks? How can Canadians minimize their tax liabilities from U.S. investments?
The United States IRS requires tax withholding on certain types of income based on the country of residence of a foreign person. Canada and the U.S. have a tax treaty called the Convention Between Canada and the United States of America, mutually signed in 1980, with various protocols (amendments) since then.
The treaty requires 15% tax withholding on dividends and 10% tax withholding on interest. If a Canadian resident owns a U.S. stock, there is a 15% withholding tax on any dividends earned. If a Canadian resident owns a U.S. bond, there will be a 10% withholding tax on any interest earned.
Importantly, the investment management company or financial institution where you own your U.S. investments should request you complete a Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting.
Without this form, the default withholding tax rate for a foreign person earning dividends or interest in the U.S. is 30%. However, you do get to claim the foreign tax already withheld by the U.S. government. Canada Revenue Agency (CRA) allows you to claim a foreign tax credit for foreign tax paid in order to avoid double taxation of the income.
To minimize or reduce taxation on withholdings, Canadians should ideally hold U.S. securities vis-à-vis an RRSP (Registered Retirement Savings Plan). It is also important to note that registered accounts like RRSPs have an exemption from U.S. withholding tax if a Canadian owns U.S. stocks, bonds or ETFs that own U.S. investments directly.
But if you own a Canadian mutual fund or ETF that owns U.S. investments, the fund itself will have withholding tax that reduces the return on these investments in your registered account. TFSAs (Tax-Free Savings Accounts) have no such exemption from U.S. withholding tax.
How can Canadians minimize currency risk from U.S. dollar-denominated investments?
Long-term studies on currency risk conclude that investors do not benefit from hedging foreign currency exposure. In fact, the 20-year annualized return for the S&P 500 was 8.3% in Canadian dollars and 8.2% in U.S. dollars, according to The Globe and Mail, Canada’s national business daily.
Over the short term, however, currency markets are volatile and can benefit or dilute your total returns in a foreign currency-denominated security. Canada offers the retail investor more than a dozen hedge CAD-based ETF products that neutralize U.S. dollar and non-Canadian dollar currency exposure. One of the leaders in this sector is the Horizon ETF family.
Are there Canadian dollar-denominated ETFs or mutual funds of U.S. stocks? Are there any broad-market funds you particularly recommend to Canadian investors?
Canada offers a wide variety of CAD-denominated ETFs and mutual funds invested in U.S. equities. Of these, Vanguard ETFs offer the lowest fee structure. For example, the Vanguard FTSE Canada ETF (VCE) charges only 0.05% per annum in total expenses – it’s the cheapest ETF in Canada.
Our favorite ETF for long-term investors in Canada is the Vanguard Canadian High Dividend Yield Index (VDY), yielding 3.34% and charging 0.22% per annum in expenses. Canada has lagged most foreign markets this year, following a strong 2016. Energy stocks have been especially slammed amid a new bear market for oil.
We also like the Vanguard Global Value Factor ETF (VVL), offering greater bargains than most plain-vanilla ETFs at this stage of the economic cycle. The median stock in this portfolio trades at book value. The ETF focuses mostly on U.S. value stocks and some foreign equities with a significant weighting in financials. The ETF charges 0.35% per annum in expenses.
Is there anything Canadian investors should keep in mind when buying U.S. income investments, like bonds and dividend stocks?
Canadian investors should keep a keen eye on withholding tax regimes when venturing overseas. CRA has a useful link on this subject. Finally, we strongly recommend the assistance of a tax specialist prior to purchasing foreign securities or international real estate.
We hope this article has helped clear up some common questions about U.S. investing for our neighbors to the north. If you have any additional questions about U.S. investing for Canadians, leave them in the comment section below. We’ll get back to you as soon as we can.