Building a Simple Low-Cost Indexed ETF Portfolio in USD

With recent articles about all-in-one ETFs and withholding taxes on ETFs in registered accounts, I’ve been getting questions about if there are USD based all-in-one ETFs, and if not, what are the most efficient USD ETFs to own?

There are a number of readers who make their money in USD, and there are some advantages to using USD for your investments.  Namely, to reduce withholding taxes on ETFs within registered accounts.

Wait what?  Withholding taxes within a tax-sheltered account?

Here is a high-level summary of withholding taxes on ETFs in registered accounts (you can read the full article here):

While holding US stocks directly in an RRSP gets preferential tax treatment, did you know that an ETF that holds underlying ETFs does not qualify for the tax exemption?  So essentially with the additional embedded tax, you are paying a higher MER than you think!

International equities would be subject to withholding tax in an RRSP/TFSA, and gets even larger if the international ETF holds underlying ETFs (Yes, two levels of withholding tax).  The bright side is that the more popular international equity ETFs like iShares XEF and Vanguard VIU hold individual stocks, which results in only one level of withholding tax.

Withholding taxes can really add to the overall MER of your portfolio – especially in registered accounts. No longer is the advertised MER of XUU (covers US market) 0.07%, but after withholding taxes in an RRSP, it’s 0.39%!

Reducing the Added Expense of Converting CAD to USD

As mentioned above, you can further avoid withholding taxes and reduce your MER if you are willing to transfer your CAD to USD and buying the US versions of the ETF.  For example, since XUU (covers US index in CAD) is an ETF that holds underlying ETFs, it will be hit with non-recoverable withholding taxes in a TFSA/RRSP.

So buying a USD ETF that holds stocks directly, like VTI, would be much more efficient.  In an RRSP, this will result in a difference of 0.39% total MER for XUU vs. 0.04% total MER for VTI.  In real money, that’s $35/year for every $10k in your RRSP.  That’s not much now, but if your RRSP grows to $500k, that’s $1,750/year.  That’s almost enough to fly the family to Florida annually!

But, as you probably already know, there is an added cost of doing foreign currency exchange (FX) where most discount brokerages charge an extra 2.5% (or more) on the conversion.  Converting $10,000 CAD into USD, it would be an additional $250 which equates to about 25 trades with most brokerages.  Or imagine doing FX on $100k, that would be an added cost of $2,500!

Fortunately, there are some strategies to reduce the 2.5% surcharge on FX conversions and it’s called the Norbert’s Gambit.

At a high-level, this strategy involves buying/selling equities that are listed on BOTH the Canadian and US exchanges (ie. interlisted stocks).  Essentially, you buy an equity in one exchange, then sell the exact same equity on the other exchange.

For example, Horizon ETFs has created a product (DLR/DLR.U) specifically to move money efficiently between CAD and USD.

This is how we do the DLR/DLR.U conversion with our accounts at Questrade.

1. Buy the DLR ETF in CAD;
2. Ask the discount brokerage to journal your CAD DLR position to USD DLR.U (usually by phone/online chat and free of charge, others are automatic); and,
3. Sell DLR.U in the US market.

Using DLR for your FX will result in a total fee of about 0.50% plus the cost of commission.  With Questrade, there is no commission to buy ETFs, but a commission to sell ($4.95).  Using the same $100k example above, instead of paying $2,500, you would pay $505.  Or, instead of paying $250 on $10k, you would pay $55.

If you want to get super efficient, you can use a high-volume interlisted stock, like TD or RY to buy on one exchange and sell on another.  This cost will effectively be the trading commission only.  More details in this post about Norbert’s Gambit.

Simple Low-Cost Index ETF Portfolios in USD

As you can see, owning US-listed ETFs can have significantly lower fees due to reduced withholding taxes.

With super simple ETFs available in CAD like Vanguard’s VGRO/VBAL; iShare’s XGRO/XBAL; or BMO’s ZGRO/ZBAL, is it worth switching to a US equivalent?

To start, the closest US equivalent to all-in-one ETFs available to Canadians would be to buy an all-world ETF, or to buy the US index plus an international index.

Portfolio Option 1: 

• Vanguard Total World Stock ETF (VT)
• Total MER 0.22% in RRSP

This will give you market cap weighted index exposure to world equities with over 8000 stocks (including Canada with 5% weighting).  Essentially, this single ETF will hold all of the largest companies in the world.  Similar to iShares XAW (CAD), except that you would need to add a Canadian ETF.

From a price perspective, iShares XAW costs 0.58% in an RRSP which is 0.36% more expensive than VT.  For larger RRSP portfolios, it may be worth switching from XAW to VT.

Portfolio Option 2:

• Vanguard Total Stock Market ETF (VTI)
• Vanguard Total International Stock ETF (VXUS)
• Assuming 60/40 split, the total MER is approximately 0.17% within an RRSP

Portfolio Option 3:

• iShares Core S&P Total US Stock Market ETF (ITOT)
• iShares Core MSCI EAFE International ETF (IEFA)
• iShares Core MSCI Emerging Markets ETF (IEMG)
• Assuming 60/30/10 split, the total MER is 0.18% within an RRSP

Depending on the amount of control you need in your portfolio, then options 2 and 3 may be of interest.  Personally, I like the idea of owning a single ETF to get global coverage at a relatively low cost.

Final Thoughts

Withholding tax on ETFs can be a complex subject, but I like to keep it as simple as possible by focusing on the solution.  That is, if you want the ultimate efficiency in your ETF portfolio within your RRSP, then it’s best to own US-listed ETFs for your ex-Canada coverage.

While converting your CAD to USD can be pricey, this cost can be significantly reduced by using a strategy called Norbert’s Gambit.  This strategy involves buying/selling equities that are listed on BOTH the Canadian and US exchanges (ie. interlisted stocks).

Finally, there are a few options to build your portfolio with US-listed ETFs.  Out of the three options above, I prefer either a single ETF to index the world, or I could even stretch to a couple of ETFs for a little more control.  Both offer a better overall MER (0.18%-0.22%) than something like the popular iShare’s XAW (0.58%).

What do you think?  Are the savings worth the fuss of investing in USD?