When purchasing foreign investments, Canadians should always be aware of rate exchange risk. This is not just the calculated risk that an individual takes when buying an investment, but also the currency exchange risk. It’s quite possible that the exchange rate can change so much in one direction, that it may affect the return on investment once it’s cashed out.
The value of the Canadian dollar has fallen dramatically against the U.S. greenback, reaching an 11-year low of 68.05 in January of this year. Many Canadians holding onto U.S. investments are celebrating their currency win. Not only are their investments making money but so is the currency in which they’ve purchased them. Many, rightfully so, are thinking they made the right decision to buy U.S. dollar investments when our Canadian dollar was stronger. However, investors need to be aware that the win may not be as big as they think.
Related read: How to get over investor anxiety
Fixed Income Products
Financial instruments like GICs guarantee your principal investment and generally pay a fixed amount of interest over their term. Using a 5-year fixed-rate GIC paying two per cent as an example, if you invest $1000 today it will be worth $1105.08 at the end of its term.
Now imagine you bought that GIC in U.S. dollars. Depending on the exchange rate, you could make additional gains if the U.S dollar is stronger against the Canadian dollar when the term expires.
But … Beware of Taxes!
Imagine that you purchased the American dollar GIC when the Canadian dollar was on par with the greenback. If we use the exchange rate as of the midpoint of 2016, $1105.08 USD would amount to $1431.00 CAD. This would result in a profit of $431 when you add up the interest paid on the GIC and the gain in value in the U.S. dollar.
When you cash out your GIC, this must be claimed as income and therefore, it will be taxed. Come tax filing time, it will be subject to capital gains tax when you fill out your return. Capital gains tax are levied on half the amount earned, so $215.50 would be added to your total income and it will be taxed within your current income tax bracket.
Related read: Should ETFs be part of your investment strategy?
How to Keep more of your Money
When it comes to purchasing foreign investments, buyers are limited to what can be held within registered accounts like RRSP and TFSAs. If you want to be tax efficient, though, these are the two best vehicles for keeping more of your returns in your bank account.
A final tip: Look into American investments priced in Canadian dollars. These will grow just as American investments do, but they are already converted to Canadian dollars. And if you can, hold as much as possible in your registered accounts, which are either tax deferred or tax-free.
It’s important to note that these tax rules apply to all gains made on any security held outside of a registered account. If you have concerns, talk to an accountant who will help you make your investments more tax efficient.
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