It’s that time of year where I have the joy of reading everyone’s “year in review” posts on LinkedIn that self promote to the world audience and justify the importance of their highly sanitized goals that were achieved. In addition to that and my facetious mindset, it’s that time of the year where so called “market experts” try to predict what 2020 holds in store for investors.
On a serious note, its that time of the year where people should be reviewing their financial situation and reflect on what worked and what didn’t work financially for them in the prior year. It’s always easy to pinpoint areas to optimize spending or saving, but one area that may be over looked is the amount of money lost on currency conversions. While this can apply to any currency conversion, for the sake of this article, I will focus on conversions between Canadian dollars (CAD), and US dollars (USD).
When someone wants to convert between CAD and USD, usually this is done via a foreign currency desk or through a bank. These two options will typically have USD on hand to give out in exchange for the equivalent CAD at the current exchange rate, plus a conversion fee of approximately 2% in most cases. This fee gets worked into the currency conversion ratio that a bank or foreign currency desk will charge. While this fee may seem irrelevant for small currency exchange quantities, it does make a difference when exchanging currencies of large sums of money. Thankfully, there is a way around this, and that way is called Norbert’s Gambit.
Norbert’s Gambit is a method to transfer between Canadian and US dollars at a very small cost in your brokerage account compared to paying the exchange rate that your broker would charge otherwise. Like a bank would do, an online brokerage firm will charge a fee to transfer Canadian funds into US dollars, and vice versa. The fee that brokerages charge can be more than what banks would charge. Again, for small dollar quantities such as a few hundred dollars, it’s not worth the hassle to find a way around paying a conversion fee. But when we are talking about thousands of dollars that are to be converted between CAD and US currencies, then Norbert’s Gambit can save you a lot of money and help avoid high currency exchange brokerage fees.
The gambit here is very simple (and yes the guy who discovered this method is named Norbert). To convert between CAD and USD, one must first purchase a Canadian equity that also traded on any US stock exchange. As with any equity purchase, the broker will charge their usual transaction fee. Once a Canadian equity has been purchased, the individual then needs to phone their broker and tell them to journal the transaction as a US holding instead (they’ll know exactly what you are doing). On the brokers end, this means changing the end of the ticker symbol in the journal entry from ABC.TO to ABC.U.TO, or whatever the naming convention is from the Canadian exchange to the US exchange. After a few days once the equity purchase has been settled, the holding will now show the holding as a US holding in USD free of charge. Now you have USD in your account and you can just sell the holding right away to have access to the USD cash. The obvious risk here is that the holding moved lower in price over the few days window, in which your cash position will have decreased. To avoid this, many Norbert’s Gambit articles suggest deploying this strategy with an ETF called DLR.TO. This ETF is denominated in Canadian dollars and tracks the USD to CAD exchange rate. So by buying this ETF, you are essentially locking in the exchange rate in which you are converting CAD to USD at. Keep in mind that if this strategy is being done in a non registered account, then capital gains/losses will have to be tracked if rates move suddenly during the interval between the two transactions (buying and selling of equity holding across exchanges).
To summarize:
Buy Canadian holding with Canadian dollars that also trades on a US exchange (example, buy DLR.TO)
Phone broker and tell them to change the ticker symbol in journal entry from the Canadian one to the equivalent US exchange one (example, change ticker from DLR.TO to DLR.U.TO)
Sell US holding for US cash (example, sell DLR.U.TO)
That’s it. It’s that simple. No currency conversion fee or any other hidden fees besides the usual broker transaction fees for buying and selling an equity position. Even better, if the individual is purchasing an ETF traded on both exchanges, it’s not uncommon for online brokerages nowadays to offer free ETF purchases and sales. In these instances, the conversion from CAD to USD has just become completely free. This exact same strategy applies for converting USD back into CAD dollars. Let’s run through an example.
Let’s say Rhonda has $10,000 CAD in her online brokerage account that she would like to use to buy some US equities. She can either transfer this money to a US non registered account, or buy a US holding directly in her Canadian non registered account. Either way, a currency conversion will take place. To convert this into USD, her online broker would charge her say an additional 2% conversion fee on top of the exchange rate of 1.33 CAD to 1 USD (that’s roughly what it is today). So Rhonda would be charged $200 CAD on this currency conversion, and be left with roughly $7,368 USD of funds to purchase US equities (she would be converting $9,800 CAD after the conversion fee has been subtracted). An additional transaction fee will be charged once Rhonda actually buys a US holding as well.
Instead, let’s say Rhonda uses Norbert’s Gambit to convert her $10,000 CAD into USD. She buys DLR.TO at $13 per share, which translates roughly to 769 shares. She then phones her broker and tells them to change the ticker symbol in the journal entry to DLR.U.TO. After the transaction has been settled in her account, she now owns shares of the US ETF DLR, and sells those shares to have US cash in her account. As seen in Table 1 below, there are ample cost savings when the amount being converted is very large. For $100,000, instead of fees making up 2% of the total converted amount, Norbert’s Gambit reduces this percent to just 0.02% (of course assuming you only pay a transaction fee once to buy and sell one bulk of equities worth the full amount being converted, as opposed to multiple times because of partially filled orders).
Table 1: Norbert’s Gambit vs. Standard Currency Conversion
It is worth mentioning that this strategy can be done in non registered accounts, and depending on the broker, it can be done in registered accounts as well. Also to reiterate, this strategy is only worth it when converting thousands of dollars between CAD and USD. In most cases, you will be charged a transaction fee to sell your US holding or ETF to have US cash (which is typically between $5 to $10), even if your broker offers free ETF purchases. Therefore, if the amount you would be saving in currency transaction costs through Norbert’s Gambit is only around $5 to $10, then this strategy isn’t really worth it, and you are better off just going through the motions of paying a currency exchange fee when buying a US holding with your Canadian dollars.
This simple yet effective strategy is an easy way to convert large sums of money between CAD and USD without being subject to excessive currency exchange fees charged by a bank or other broker. It is completely legal and online brokerage firms are fully capable to handle this sort of “gambit”. Now reading about the use of this strategy in someone’s year end review deserves some attention! No justification of importance is needed here.