A commenter named Blitzkrieg asked:
How do currency exchange fees factor into the decision between VEA and XIN? XIN’s MER is 0.35% higher than VEA’s, but it is purchased using Canadian dollars, so there is no exchange fee. VEA’s MER is nice and low, but don’t you immediately lose a few percentage points of your investment when you buy it due to currency exchange fees?
He’s exactly right. The answer to “which one is better, VEA or XIN, from a cost perspective” is “it depends.” In this case, it depends on how long you hold your investments.
I did some similar calculations to determine the “effective MER” of a foreign currency investment over time but this time I do it a bit more simply, to determine, simply, how long to I have to hold my VEA until it beats XIN.
When you buy VEA, you’ll pay a foreign exchange fee (spread). This varies depending on your broker but they range from 0.5% to 1.5% each way. Let’s assume it’s 1% each way. So when you use Canadian dollars to buy VEA they convert your dollars to USD but they take 1.5% for themselves. So our present value has gone down by 1.5%, or 98.5% of the original. When we sell your USD investment, VEA, in the future, the broker/banks will again take 1.5%. So your final value is also reduced by 1.5%. So originally, we had this:
Our initial PV needs to get reduced to 0.985 of the original, and the result of the right-hand needs to be reduced by 0.985 (when we sell the investment). So what we end up with is this:
If we invest in XIN, there are no foreign exchange, just an MER that is 0.35% higher. This 0.35% will reduce our annual return, so we get this:
We can get rid of PV (it won’t affect the result) and assume a return of 7% (i=0.07). It turns out that:
So if we hold onto our investment in VEA for 10 years or greater, we will end up better off, assuming a rate of return of 7% (note that the rate of return does not have much effect here, eg. 10% rate of return gives the same result) and a foreign exchange fee of 1% each way. The two variables that have the greatest effect here are the foreign exchange fee and the difference in MERs.
thanks for this. The foreign currency exchange fees complicate the decision to stay with ETFs denominated in CAD$ versus those purchased in other currencies. Is there anyway to reduce these exchange fees?
If you read the post above, the key is to not trade them. Just buy once, hold it, and sell when you retire. This way you minimize the amount of times you pay foreign exchange costs (twice) and you also increase the advantage of the lower MER once you have held it for many years (10 years in the example above).
One thing you did not address is the exchange rate costs associated with Dividends. With each dividend getting hit with a loss of 1%, it will make it less desirable to own a US based ETF vs a CAD based ETF. Additionally, some Canadian stock brokers don’t do DRIPS for VEA, but they do allow it for XIN.
Things to consider before swapping XIN for VEA. I’m still on the fence whether it makes sense for me.
My comments are assuming you have a CAD based account (in my case my RRSP). So you get hit with the exchange rate both ways (div to you, then stock purchase with dividends)