Opportunities abound to use international investments when saving for retirement.  But even the most successful investment can be impacted by currency fluctuations.

The foreign content limit for RRSPs was eliminated in the 2005 Federal Budget, allowing Canadians further diversification in their retirement portfolio.  With this opportunity however came additional risk.

A simple example

The impact of currency fluctuations can be seen in the following example. Our fictitious friend Jane decides to purchase shares in Coach Inc., because she loves Coach purses and believes that the company’s stock will increase dramatically.  She buys 100 shares at $11.80US on March 6, 2009. 

The exchange rate on that day is $1.2863, so the stocks cost her $1,517.83CDN.  For simplicity we will ignore dividends and brokerage fees.

On January 9th 2010 Jane decides to sell her Coach shares which have risen to $37.27US per share yielding $3,727US, a $2,547US or 216% gain. The exchange rate on that day is $1.0344 meaning the value of the Canadian dollar vs. the US dollar has risen since she purchased her shares, making her US dollar denominated stocks worth less Canadian dollars.  Therefore in Canadian dollars her stocks on sale were worth $3,855.21CDN, a $2,337.37CDN or 154% gain.

Coach share purchase and sale example ( 100 shares)
  Share Price $US Cost $US x Exchange Rate ($1 USD) = Cost $CDN
Mar 6, 2009 $11.80 $1,180.00 $1.2863 $1,517.83
Jan 9, 2010 $37.27 $3,727.00 $1.0344 $3,855.21
$ Gain on sale   $2,547.00   $2,337.37
% Gain   216%   154%

 

Without exchange rate fluctuations, her gain would have been $3,276.20CDN, which means she lost $938.84CDN due purely to changes in the relative value of the Canadian dollar vis a vis the US dollar.

Mitigating exchange rate risk

The risk isn’t always downside risk – one can gain on the exchange rate as well when the foreign currency appreciates relative to the Canadian dollar.  However, when thinking about investments denominated in foreign currencies, one should include exchange risk when assessing their overall relative risk tolerance.

Relatively small holdings such as an individual’s RRSPs cannot support hedging operations akin to those that large institutions and multinationals undertake, so what’s a little guy to do?   Educate yourself about currencies – read the forecasts and consider them in whether it makes sense to purchase the stock, and when it makes sense to sell.  Then keep an eye on the exchange rate and time your sale to optimize a) the price of the stock, and b) the currency to maximize your overall return.  Build this “cost” into your equation, much like you would your brokerage fees, or capital gains…it’s just a little harder to estimate.

Yes, foreign investments offer a wealth of opportunity for Canadians.  With the proper consideration of all of the risks, we can make better informed choices.