Is it Worth it to Hold U.S.-Listed ETFs?
Index investors in Canada who own Exchange-Traded Funds (ETFs) have a choice to make with their U.S. and international stock holdings. They can either buy an ETF that holds U.S. and international stocks but trades in Canadian dollars (such as Vanguard Canada’s VXC), or they can buy U.S.-listed ETFs that trade in U.S. dollars. This choice is a trade-off between cost and complexity.
It’s certainly a lot simpler to own VXC. With U.S.-listed ETFs, you need to find an inexpensive way to exchange Canadian for U.S. dollars, such as Norbert’s Gambit. But, as Justin Bender explained, the cost of VXC is higher than the cost of owning U.S.-listed ETFs. This higher cost comes from a higher Management Expense Ratio (MER) and U.S. dividend withholding taxes.
For the mix of U.S.-listed ETFs that I own (VTI, VBR, and VXUS), the blended MER is 0.09%, which is 0.18% lower than VXC’s MER. Less obvious, as Justin calculated, is the fact that U.S. withholding taxes of 0.35% cannot be recovered for VXC. This tax is not charged to VTI, VBR, and VXUS when they’re held in an RRSP. There are international dividend withholding taxes that apply to both VXC and VXUS.
From this total of 0.53% in lower costs for U.S.-listed ETFs, we need to subtract the added costs of currency exchanges. In my case, this averages about 0.01% per year using Norbert’s Gambit. However, this cost would be higher for smaller portfolios and much higher for investors who don’t use Norbert’s Gambit. In total, my costs would be about 0.52% higher each year if I owned VXC.
I plugged this higher cost into my retirement spending spreadsheet and found that my estimated lifetime retirement income derived from my portfolio declined by 5.6%. So, for example, if my portfolio was going to produce $50,000 per year, this would drop by $2800 per year if I owned VXC instead of my U.S.-listed ETFs.
Now that I’m comfortable managing a portfolio that includes very infrequent Norbert’s Gambit currency exchanges, I find the added complexity of dealing with U.S. dollars to be worth it for the extra income, but your mileage may vary.
It’s certainly a lot simpler to own VXC. With U.S.-listed ETFs, you need to find an inexpensive way to exchange Canadian for U.S. dollars, such as Norbert’s Gambit. But, as Justin Bender explained, the cost of VXC is higher than the cost of owning U.S.-listed ETFs. This higher cost comes from a higher Management Expense Ratio (MER) and U.S. dividend withholding taxes.
For the mix of U.S.-listed ETFs that I own (VTI, VBR, and VXUS), the blended MER is 0.09%, which is 0.18% lower than VXC’s MER. Less obvious, as Justin calculated, is the fact that U.S. withholding taxes of 0.35% cannot be recovered for VXC. This tax is not charged to VTI, VBR, and VXUS when they’re held in an RRSP. There are international dividend withholding taxes that apply to both VXC and VXUS.
From this total of 0.53% in lower costs for U.S.-listed ETFs, we need to subtract the added costs of currency exchanges. In my case, this averages about 0.01% per year using Norbert’s Gambit. However, this cost would be higher for smaller portfolios and much higher for investors who don’t use Norbert’s Gambit. In total, my costs would be about 0.52% higher each year if I owned VXC.
I plugged this higher cost into my retirement spending spreadsheet and found that my estimated lifetime retirement income derived from my portfolio declined by 5.6%. So, for example, if my portfolio was going to produce $50,000 per year, this would drop by $2800 per year if I owned VXC instead of my U.S.-listed ETFs.
Now that I’m comfortable managing a portfolio that includes very infrequent Norbert’s Gambit currency exchanges, I find the added complexity of dealing with U.S. dollars to be worth it for the extra income, but your mileage may vary.
Another good article. With US based ETF's does the same rule apply to withholding taxes not being applied hold true once the RRSP is turned into a RRIF? I only have $58K of US stocks (iShares XDG and BMO ZWU) in my RRSP so the $300 in savings isn't worth the Norbert's Gambit. For ease of management I treat each of my accounts (Cash, TFSA, RRSP and LIRA) as separate portfolios at 60/40 ratios of equity and fixed income.
ReplyDelete@Marko: Thanks. My understanding is that U.S. dividend taxes aren't withheld within both RRSPs and RRIFs. You;re right that you need to have substantial U.S. stock ETFs to make owning U.S.-listed ETFs worthwhile.
DeleteMJ-do you treat all the accounts in your portfolio as one when you determine asset allocation? For example, maybe I should put all or most of my entire US stock allotment into my RRSP that has $310,000 in it? And then do the Norbert's Gambit? I would allocate 20% of my assets to US based stocks.
Delete@Marko: Yes, I do treat all of my accounts as a single portfolio. I also discount each account based on the percentage of tax I expect to pay. This discount is largest for RRSPs, smaller for non-registered accounts, and zero for TFSAs. I put as much of my U.S. ETFs as I can into RRSPs to minimize U.S. dividend withholding taxes.
DeleteThanks MJ-now that I am retired I may end up doing the same now.
DeleteMichael, you say 'I put as much of my U.S. ETFs as I can into RRSPs to minimize U.S. dividend withholding taxes', right after you explain how to avoid these tax altogether. Why not keep them in US? What do I miss here?
ReplyDelete@AnatoliN: I'm not sure I fully understand your question, but let me take a shot at an answer. When you ask "Why not keep them in US?", I'm not sure whether you mean keep the ETFs in U.S. dollars or keep the ETFs in the United States. I do keep them in U.S. dollars within my RRSP. I don't have the required status in the U.S. to open an account there. Even if I did, I imagine this might cause more problems than it solves.
DeleteTo eliminate U.S. withholding taxes on dividends, I need to have the investment in my RRSP. This is because of tax treaties in place between Canada and the U.S.
Michael, sorry for being unclear. Your guess was correct, regardless.
DeleteMy understanding is that by ETFs kept in USD under RRSP avoid US dividend withholding tax. Am I to understand that your strategy is to
(1) establish desired allocation for all accounts combined,
(2) put as much as you can of US-nominated ETFs into RRSP (in CAD or USD, minor difference in MERs),
(3) use Norbert's gambit to convert CAD to USD for investment in USD-nominated ETFs?
@AnatoliN: (1) is correct. For (2), I use the U.S.-denominated ETFs in my RRSP in U.S. dollars. These only trade in U.S. dollars, so I'm not sure what you mean by "in CAD or USD, minor difference in MERs." The Canadian-dollar ETFs with similar holdings have a difference in MERs, but they also don't work to prevent the U.S. dividend withholding tax. The extra layer of ownership where the Canadian ETF owns the U.S. stocks prevents the tax treaty from kicking in. For (3), yes I do use Norbert's Gambit for U.S./Canadian dollar exchanges.
Deletethank you
Delete