Previously, I wrote about the ways that Canadians can invest in the major U.S. stock indexes using Canadian-denominated exchange-traded funds (ETFs). I recommended this approach because, for the majority of retail investors, currency conversion costs are expensive and a hassle, and they reduce returns.
Even with the higher management expense ratios (MER), foreign withholding tax (FWT), and currency risk, Canadian-denominated ETFs are still the cheaper, easier option for investing in U.S. stocks. There is an exception, though.
If you are comfortable with using Norbert’s Gambit to convert CAD to USD for cheap (which I covered earlier with a how-to guide) and are investing in your Registered Retirement Savings Plan (RRSP), you can save significantly by using a U.S.-denominated ETF.
Why do we want U.S. ETFs in an RRSP?
If currency conversion fees are a non-issue, then U.S. ETFs are preferable in an RRSP for two main reasons:
- MER: The MERs of U.S. ETFs are dirt cheap, often coming in 50% or more lower than their Canadian counterparts. Our ETF industry tends to have higher fees compared to our southern neighbors.
- FWT: U.S. stocks and ETFs incur a 15% tax on dividends. For example, a normal annual dividend yield of 1.50% would be reduced to 1.275%. However, this does not occur in an RRSP because of a tax treaty with the U.S., allowing you to maximize gains.
Which ETFs should you buy?
A great pick here would be Vanguard Total World Stock ETF (NYSE:VT) for a truly passive approach to getting the market’s return. VT is diversified among over 9,000 U.S. and international stocks in a roughly 55/45 split. All this will cost you an extremely low MER of just 0.07%.
If you’re bullish on the U.S. continuing to outperform, you can buy the entire American stock market with Vanguard Total Stock Market Index ETF (NYSE:VTI). VTI holds over 3,000 large-, mid-, and small-cap U.S. stocks for an even lower MER of 0.03%.
Keep in mind that with VT, you’ll still incur some foreign withholding tax. Although it is a U.S. ETF, it does also have international holdings. These stocks are subject to a 15% FWT as the countries of origin do not have the same tax treaties with Canada as the U.S. does. The cost of this drag is around 0.12% per year, which isn’t bad and shouldn’t deter you from investing.
The Foolish takeaway
If I had to pick, I would choose VT. Yes, I know the U.S. stock market has been on a tear recently. Reversion to the mean will occur. There have been periods of time (2002-2009) where the U.S. severely lagged behind the world.
I do not have a crystal ball and am terrible at timing the market. Therefore, I accept the overall market’s return by buying the world stock market as it is. This is the best way to truly implement a passive investment strategy.
