High US Dollar Getting You Down?
By Michael Woods, CFP, CIM
Friends of mine, Walter and Winnie Bago, are typical Canadian Snowbirds. They love spending their summers in the beautiful Okanagan sunshine, but by the middle of November they are travelling south, enjoying the Oregon Coast en route to Palm Springs. While they find this lifestyle very relaxing, it does come with unique challenges, such as paying U.S. dollar expenses with Canadian dollar income. While this situation is a positive when the Canadian dollar is above par, it stretches their budget when the dollar drops. Walter and Winnie have often wondered if there is anything they can do to smooth out the fluctuations in their purchasing power.
One option for them would be to try and generate U.S. dollar income to pay for their U.S. dollar expenses. A strategy to achieve this goal would be to open up a U.S. dollar investment account and make investments in U.S. listed entities. Many household names, some that you may even find in your own home on a daily basis, have their common stock listed on the U.S. exchanges. Furthermore, these types of investments often offer a reasonably secure stream of dividend income that is paid to investors in U.S. dollars. If Walter and Winnie prefer to not take on the risk of equity investments, they could put their capital to work in fixed income securities of similar U.S. listed investment grade corporations which pay interest income in U.S. dollars. Investing in a basket of these securities would generate a stream of income in U.S. dollars that could be used to offset their U.S. dollar expenses. While they would have to initially exchange their Canadian dollars for U.S. dollars, they would no longer need to worry about the fluctuations in the exchange rate.
If Walter and Winnie lack the financial capacity to make a lump sum investment in U.S. dollars, they could consider a plan of monthly contributions into a U.S dollar bank account. The benefit of this strategy is that over time they will smooth out the impact of foreign exchange fluctuations. There are many theories on where the Canadian dollar should be, and will be, relative to the U.S. dollar. By purchasing small amounts of U.S. dollars over time, Walter and Winnie need not worry so much about the dollar’s direction. For instance, if this strategy is implemented over a market cycle, there will be times when U.S. dollars are purchased at a perceived premium and discount, but over the long-term, the purchases will average out and it is probable that the U.S. dollars will be purchased close to fair value.
Looking at the big picture of their expenses may lead Walter and Winnie to realize they have no need for either of these strategies. When making the annual trip south in their RV, one of their largest expenses may be the cost of fuel. There is a high correlation between the drop in the Canadian dollar relative to the U.S. dollar and the price of oil. If the price of oil falls, they may be paying extra for every U.S. dollar they purchase, but they are more than likely to offset that higher cost with fuel savings. When the reverse happens and the Canadian dollar strengthens, some of the benefits they receive with their greater purchasing power will be offset with higher fuel costs.
Planning in advance to be a snowbird can be beneficial if you are at a stage in your life where you are accumulating wealth. For instance, if you have a number of years left in your career and winters in the south are a goal for your retirement, you can begin building a nest egg of U.S. dollar investments now. By planning and building this early, you could benefit from the compounding growth of your investments over time, providing you with a larger principal to generate your U.S. dollar revenue in the future. Also, by accumulating this nest egg over multiple economic cycles, you will likely end up having an average cost of your U.S. dollars near fair value.
When investing in foreign assets, it is also important to be aware of the Canada Revenue Agency (CRA) Foreign Income Verification rules, as well as your potential exposure to U.S. estate tax. The penalties for non-reporting can be quite significant, and it is highly recommended that you consult your tax professional for advice when venturing down this path.
Each individual will have different circumstances and objectives, but by looking at the possibility of incorporating one of these strategies as part of your overall plan, hopefully you will be in a better position as a current, or future, Walter and Winnie Bago.
Michael Woods is a Portfolio Manager with Odlum Brown Limited
The information contained herein is for general information purposes only and is not intended to provide financial, legal, accounting or tax advice and should not be relied upon in that regard. Many factors unknown to Odlum Brown Limited may affect the applicability of any matter discussed herein to your particular circumstances. You should consult directly with your financial advisor before acting on any matter discussed herein. Individual situations may vary. Member-Canadian Investor Protection Fund.