Q: I wonder what you think of buying U.S. stocks? “Top Picks” usually names several stocks traded on the NYSE or NASDAQ as good investment buys. Using a discount brokerage, you have a choice of “settlement funds” in Canadian dollars or U.S. dollars. Is there an advantage one way or the other and similarly if I sold a U.S. stock? Or with the Canadian dollar as bad as it is, is it still worth even considering the purchase of U.S. stocks?
A: I think that the most important decision in building a portfolio is asset allocation, Phil. Fees and taxes are also important, but a portfolio built of top picks that are all from the same sector is risky and unlikely to generate the same risk-adjusted returns as a well balanced portfolio.
On that basis, I would caution a do-it-yourself investor from building a portfolio of top picks. I’d be more inclined to build a portfolio based on what pieces are missing and fill them in with the best options.
Assuming that you are doing that, Phil, a well-diversified portfolio should ideally include U.S. stocks. And that’s nothing to do with currency–it’s more to do with diversity. Canadian stocks are rather non-diverse by nature, given that 2/3 are financial, energy and materials companies. Sectors like consumer, health care and technology are difficult to access without going beyond Canada’s borders.
When you invest abroad, foreign exchange risk becomes a factor, but when you don’t, concentration risk becomes a factor. Case in point, the technology-centric NASDAQ stock exchange has risen 14% in the past year (in U.S. dollar terms), while the energy sector of the Toronto Stock Exchange is down 35%. That’s nearly a 50% difference in returns over just a 1-year period–so does, say, a 10% higher shift in the Canadian dollar in the coming 5 years really matter?
If I were a betting man–which I’m not–I’d wager the Canadian dollar could move lower as the U.S. dollar moves higher in the coming year. Interest rates have just been cut here and we could see another rate cut. On the other side of the border, interest rates are poised to rise and if our rates are moving in opposite directions, the U.S. dollar could continue to be strong relative to our loonie.
But if there’s one thing I’ve learned it’s that timing decisions are not likely to be successful, Phil. In fact, a Hulbert Financial Digest study of 131 investment newsletters found that only 5 of them beat the market over a 5-year period. And Nobel Prize winner William Sharpe found that market timers would need to be right ¾ of the time in order to be successful.
On that basis, Phil, I’d say it’s not a matter of if you should have U.S. stock exposure. I’d say the answer is yes. In the short run, the timing of buying those stocks may prove good or bad, but in the long run–where you’ll spend the rest of your life–it probably won’t matter.
Even if the Canadian dollar rises back to par over the coming 10 years, I’d consider it a cost of investing to get better portfolio diversification. And it will only impact a small portion of your overall portfolio anyway.
Tax is a consideration depending on where you’re holding your U.S. stocks. So suffice to say that if you’ve got RRSPs, TFSAs and non-registered accounts, you should determine the best place to hold your different investments, Phil.
To answer your question on settlement funds, this simply applies to what currency you want a sale of securities to be paid in and I’d be inclined to limit the conversion back and forth between Canadian and U.S. dollars. There is a spread on the purchase and sale rate of U.S. dollars through your discount broker that puts money in their pocket and takes money out of yours. So if you have a certain allocation to U.S. stocks in your portfolio and you sell a U.S. stock, I’d be inclined to settle in U.S. dollars and likely repurchase new investments in U.S. dollars unless your rebalancing targets suggest you should be buying Canadian dollars and securities.
One of the benefits of a passive DIY investment philosophy is that you just have to worry about asset allocation and not individual security selection. For a DIY investor who complicates portfolio management with stock picking, the least you can do is simplify your job by not having to worry about market timing. Chances are if it matters it won’t matter for long anyway, so take a long-run view for your long-term savings.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.