Canada is a great place for dividend lovers. We've got terrific banks, utilities, telecoms and pipeline companies that raise their dividends regularly.
But if you want exposure to some of the world's top consumer, technology and health-care companies, you'll need to do some cross-border shopping. The U.S. market is brimming with dividend stalwarts, some of which – Procter & Gamble, Wal-Mart, Johnson & Johnson and McDonald's, to name a few – have been raising their dividends for decades.
But before you load your shopping cart with U.S. stocks, here are some things to keep in mind.
Mind the taxes
U.S. dividends don't qualify for the Canadian dividend tax credit, so if you hold your U.S. stocks in a non-registered account, you'll pay tax at your full marginal rate.
What's more, in a non-registered account you'll face a 15-per-cent U.S. withholding tax on the dividend. You can usually recoup this amount as a foreign tax credit on your return, but the bottom line is that most people will end up paying the same tax rate on U.S. dividends as they do on interest or other income.
Choose your account carefully
You can avoid taxes on U.S. dividends if you hold your U.S. stocks in a retirement account such as a registered retirement savings plan (RRSP), registered retirement income fund (RRIF) or locked-in retirement account (LIRA). That's because, under the Canada-U.S. tax treaty, accounts that provide retirement or pension income are non-taxable.
But be careful. Many people assume that if they hold U.S. stocks in a tax-free savings account (TFSA) or registered education savings plan (RESP), they will avoid taxes on their dividends. Not true. Because TFSAs and RESPs are not retirement accounts, the 15-per-cent withholding tax still applies and cannot be recovered.
Watch currency conversion costs
If you're using Canadian cash to buy a U.S. stock, your broker will first convert your money into U.S. greenbacks – at an exchange rate that is favourable to the broker, of course.
When you sell your U.S. stock, if it's a registered account the broker will often convert the U.S. proceeds back to Canadian dollars – costing you money yet again.
How much money? I did some hypothetical currency conversions with my own discount broker, and here's what I found. On Monday (when the Canadian dollar was trading slightly above par) if I had sold $5,000 (Canadian), I would have received $4,940.71 (U.S.). If I had then converted that $4,940.71 (U.S.) back to loonies, I would have received $4,841.89 (Canadian).
So, on the currency transactions alone, I would have been down $158.11, or about 3.2 per cent of the initial $5,000. Ouch.
The good news is that there are ways to minimize the hit to your portfolio.
With registered accounts, brokers used to automatically convert U.S. dividends, and the proceeds of U.S. stock sales, into Canadian dollars. But a growing number of discount brokers now let you accumulate U.S. cash in registered accounts, without forced conversion. This is a plus, because if you reinvest your U.S. cash in U.S. securities, you can avoid conversion costs.
Brokers that provide this option include RBC Direct Investing, BMO InvestorLine, Qtrade, Questrade and Virtual Brokers. Ask your broker about its policy.
Another benefit is that, if you intend to convert the money to Canadian dollars, you can wait until the exchange rate is favourable. Alternatively, if you plan to travel in the United States in retirement, you can withdraw the U.S. funds from your RRIF when you need them.
If choosing individual stocks makes you nervous, there are numerous exchange-traded funds that invest in U.S. dividend stocks. These ETFs have low management expense ratios and provide broad diversification. Examples include the Vanguard Dividend Appreciation ETF (VIG-NYSE), WisdomTree Total Dividend ETF (DTD-NYSE) and SPDR S&P Dividend ETF (SDY-NYSE).
Bear in mind that, if the loonie appreciates, your U.S. stocks or ETFs will be less valuable in Canadian dollars. Conversely, if the loonie falls, you'll benefit. Investors can hedge their exposure with currency futures and other products. A simpler option is to buy a Canadian-traded ETF with built-in currency hedging, such as the S&P U.S. Dividend Growers Index Fund (CUD-TSX) or the BMO Dow Jones Industrial Average Hedged to CAD Index ETF (ZDJ-TSX). Be warned, however, that taxation of Canadian-listed ETFs that hold U.S. stocks is complex, as the Canadian Couch Potato blog has pointed out.
Complicating matters further, hedging is not an exact science and there are costs involved. With the Canadian dollar already trading at a premium to the U.S. buck, some investors believe that the risks of a substantial advance in the loonie are minimal, so they're happy to leave their U.S. stocks or U.S. ETFs unhedged.
Watch your weight
One way to make sure that currency swings won't have a huge impact – positive or negative – on your portfolio is to limit your U.S. exposure. For example, I keep my U.S. stocks to less than 10 per cent of my portfolio. That allows me to hold a diversified collection of great dividend companies, without losing sleep over the direction of the Canadian dollar.