How will the rising dollar hit your investments?

Strength in the Canadian dollar relative to the U.S. greenback has benefited travellers heading south for a vacation.  Apart from a cheaper holiday, many Canadians are seeing the fall out from a strengthening loonie. Exports are becoming more expensive and affecting many industries.  Some reports also state that tourism levels are dropping as vacations to Canada have become more expensive when compared to other destinations.   

Is the strength in the Canadian dollar good news for your foreign investments?  As Canadians we are very susceptible to changes in foreign exchange rates.  Investors most affected are those that hold U.S. dollar denominated investments.  We pay our bills in Canadian dollars and must calculate investment returns in the same way.

Investors with U.S. or other foreign securities should track the foreign exchange rate on the date of each purchase and sale.  Upon selling a position you will need to report the capital gains or losses in Canadian dollars on your tax return.

Here’s some examples:

Share Illustration:  Two years ago an investor purchased 200 shares of General Electric (GE) at $30 US when the exchange rate was 1 USD = 1.3685 CDN.  The adjusted cost base of the purchase in GE is $8,211 CDN ($30 x 200 x 1.3685).  Today, GE is at $35 US.  At first glance many investors looking at their investment statement may feel they have a capital gain, after all the stock has increased from $30 to $35.  If the investor were to sell these shares today the proceeds would be $7,644 CDN ($35 x 200 x 1.092) realizing a capital loss of $567 CDN.  Although the share price had increased the deterioration in the currency resulted in a loss.

Bond Illustration

Five Years ago an investor purchased a $50,000 US corporate 5 year bond when the exchange rate was $1 US  = $1.5347 CDN.  The adjusted cost base of this corporate bond is $76,735 CDN ($50,000 x 1.5347).  Assuming that the exchange rate is 1.092 upon maturity, the proceeds would be $54,600 ($50,000 x 1.092).  It may be shocking for some to believe that on maturity the realized capital loss would be $22,135 on a $50,000 bond.

Bank Accounts

For individuals holding foreign currency bank accounts and term deposits the loss may not be realized for tax purposes unless the amount in the account is converted to Canadian dollars.  One strategy may be to convert the funds to Canadian dollars at least for a period of time to recognize the loss for tax purposes.

Review US Denominated Holdings

Investors may benefit from looking at their US holdings.  Determining the date you purchased your securities and the exchange rate on that day will assist you in estimating the adjusted cost base in Canadian dollars.  If you are unsure of the foreign exchange rate on a given day an excellent foreign currency website is www.oanda.com.  The next step is to look at these same holdings and calculate the current market value in Canadian dollars.  You may be surprised by the outcome of this exercise!

Tax Planning

For many years, investors had to deal with gains relative to foreign currencies upward movements.  Over the last few years, investors may have unrealized losses on their US dollar denominated holdings that they should be factoring in to their tax planning.  Capital losses may be used to offset current year gains.  At this time, Canadian taxpayers are able to apply any realized losses back three years or carry them forward indefinitely.

Currency Risk

The illustrations above highlight the effects of a strengthening Canadian dollar relative to the US dollar.  A deteriorating Canadian dollar has the opposite effect.  Economists attempt to provide guidance by offering targets on foreign currency rates and recently, that guidance suggests further weakness in the US dollar.

We do not want to suggest that investors avoid securities denominated in other currencies.  There are some very good investment opportunities beyond our borders.  A diversified portfolio has a portion allocated to foreign denominated investments.  Many Canadian companies conduct much of their business south of the border.  Currency fluctuation will certainly influence the demand for their goods and services.

Investors who want to reduce foreign currency risk from their portfolio should assess any currency hedges that may be in place for their respective investments.  Movements in foreign currencies may have a greater impact on your Canadian dollar return than the movement in the security price.

Before implementing any strategies discussed in our columns we recommend that you speak with your financial and tax advisors.