2020 was a crazy year in many regards, and it was an unusually volatile year in the foreign exchange markets as well. The Canadian dollar (CAD) hit a low in relation to the U.S. dollar (USD) of 0.6898 on March 18. The Canadian dollar rallied over the next nine months to reach a 2020 high of 0.7863, an increase of almost 14%. The closing exchange rate on June 1, 2021, was 0.8306, an increase of over 20% from the bottom. The exchange rate has normalized since and has ranged from $0.78 to $0.83.
The weakening Canadian dollar in early 2020 presented an excellent opportunity for many of our clients to convert their USD to CAD at historically high rates. Currency exchange rates are always moving, and our clients look to us for currency exchange guidance. There are several factors to consider when considering currency conversion.
First, which currency are you going to need to fund your future lifestyle and financial goals? We do not recommend speculating on currency exchange rates which means we generally only recommend currency exchange if you will need the converted currency in the future. If we are discussing converting CAD to USD, when will you need the USD? If you need USD in the short-term, then it does not matter what the exchange rate is because you are converting out of necessity. If you will need USD many years in the future, here are some things to consider:
- How does the current exchange rate compare to the long-term historical average? If you do not need the converted currency in the short-term, you have time to wait for a better rate.
- What are the tax implications for liquidating securities to create cash to convert? The more unrealized gains you have, the larger the gain on currency exchange needed to justify liquidating. The time value of money is important, so any conversion gains need to outweigh any tax losses. At the same time, capital gains will likely continue to build in the account over time. If you know you will need the money at some time in the future, you must balance paying some capital gains tax now with the possibility of paying more tax on gains later. Additionally, we do not know what capital gains tax rates will be in the future.
- What are my investment options once I convert? The U.S. stock market has outperformed the Canadian and international stock markets for several years. That is not always the case, but the long-term average return in the U.S. market is slightly higher than international markets. This makes it slightly more attractive to convert to USD if you will be investing for a long period of time. If you need the currency of a country with less developed investment markets, then it might be better to leave the currency in USD or CAD until it is needed because of the limited investment opportunities in emerging and developing markets.
- How much would I like to convert? We do not know what will happen with currency exchange rates in the short-term, but we are confident they will revert to the mean over the long-term. If you are converting a substantial sum, is it better to convert in a lump-sum or in stages over a few months or years? You can always start with a smaller conversion amount and then convert more in a lump sum later if the economic environment changes. Keep in mind that it is unlikely that you will time the market perfectly.
- What are the fees associated with the conversion? There may be transaction fees and wire fees.
- What is the spread on the conversion? The foreign exchange provider makes money primarily from the spread. You should shop providers to get the best deal.
So, what is the long-term historical CAD/USD exchange rate? Like all statistical measures, the average depends on the timeframe you are examining. Below is a complete list of average annual exchange rates between Canada and the US since 1947. As you can see, the long-term average over the entire data set is 0.876. Data that is too old may not be relevant any longer as market conditions change over time. Over the past 50 years, the average exchange rate has varied between $0.80 – $0.83 U.S. dollars per Canadian dollar. We are slightly below that average now at about $0.78 – $0.79, so it is not the best time to convert to USD, but it is slightly better than average when converting to CAD. The exchange rate is currently close to the long-term average, so it is likely that we will see much better opportunities to convert in the future. How long are you willing to wait for better rates?
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