Canada's economy makes up about 2.5% of the world economy, but the average Canadian probably has most of their money invested in the Canadian dollar. They earn their income in Canadian dollars, and their home and most of their possessions are located in Canada. This results in currency risk, as they have all their assets in one currency. If the Canadian dollar rises, they would do well because they can buy more imported goods with their Canadian dollars. If it falls, they will be able to buy less, because the cost of imported goods will rise.
In order to reduce your currency risk, you should diversify among different economies and currencies. In the stock market, you can do this by buying companies which are based in or operate in different countries.
One way of doing this is to buy US multinational companies. These companies are based in the United States, but operate worldwide. Their stock trades in US dollars, but this doesn't mean that you are 100% exposed to the US dollar with this investment, because they are doing business in other countries. Your currency risk is spread among all the countries in which they are doing business. If the US dollar falls against other currencies, then the profits from the foreign divisions will be worth more US dollars. For example, McDonald's Restaurants has 35% of its sales in the US, 35% of its sales in Europe, 14% in Asia/Pacific, Middle East and Africa (APMEA), 8% in Latin America, and 8% in Canada and other countries. If you bought McDonald's shares, you would have 35% exposure to the US dollar, 35% exposure to the pound and the euro, 14% exposure to the APMEA currencies, 8% to Latin American currencies, and 8% to Canadian and other currencies. If you purchase the exchange traded fund (ETF) S&P Depositary Receipts (ticker SPY), your currency exposure works the same way. The majority of the companies in this ETF have international sales.
Another way of diversifying your currency risk is to buy stocks or ETFs based in other countries, such as
Even though these ETFs are bought on a US stock exchange, they give you exposure to the economies and currencies of the world. For example, HSBC, a large British bank, gets 32% of its profit from Europe, 23% from Hong Kong, 16% from the rest of Asia/Pacific, 21% from North America, and 8% from Latin America. Many of the other stocks in these ETFs do business worldwide.
One caveat about VWO is that the accounting standards and regulatory bodies in these countries may not be as reliable as those of the countries in SPY, VGK, and VPL.
See also our article on recommended stocks/ETFs for inside or outside of your RRSP.
Tax Tip: Diversify your currency risk by investing in stocks from different countries.
Revised: October 15, 2021
Copyright © 2002 Boat Harbour Investments Ltd. All Rights Reserved. See Reproduction of information from TaxTips.ca