Dealing with Dollars: Understanding how Exchange Rates can Affect Your Portfolio

If you’ve ever travelled abroad, you’ve likely felt the impact of exchange rates. Before heading to the register or ordering a meal, you do the mental math to decide if you’re getting a deal or paying more than you would at home.

The same dynamics are at play in a portfolio that holds investments in a currency other than Canadian dollars. However, an investor with a smart strategy may be able to make exchange rates work in their favour – and at times, that impact can be significant.

“Currency exposure is often an afterthought for investors, but it’s been a huge tailwind for Canadians who are invested down south,” explains Dan Mitchell, Senior Portfolio Manager on RBC Global Asset Management’s Global Fixed Income and Currencies team. That’s because when the loonie is falling relative to investments held in a foreign currency, as has been the case with the U.S. dollar in recent years, it boosts the value of your investment when converted back into Canadian dollars.

Still, as much as the exchange rate can work in your favour, it also has the potential to undercut your performance. Here’s a look at the factors that weigh on the Canadian dollar and some of the ways to manage that currency risk in your portfolio.

Where the loonie stands globally

At times you might hear the dollar referred to as being weak or strong, but that’s a little misleading. That’s because currencies always trade in pairs – with one currency being compared to another. The dollar might look strong when paired with one currency but weak against another. Typically, though, most of the time currencies are compared to the U.S. dollar.

The Canadian dollar is currently languishing at a five-year low relative to its U.S. counterpart. There are several reasons for that. For starters, the U.S. has had stronger economic growth, higher interest rates and more attractive equity returns over that period, which has encouraged investors to buy U.S. dollars to invest in that country. At the same time, demand for the Canadian dollar has been sliding as the country has been cutting rates while grappling with high consumer debt levels and lower productivity, explains Mitchell.

The brewing tariff war that the U.S. recently initiated against Canada could put further pressure on the loonie, says Mitchell, with some companies opting to delay investments until the dust settles. But that’s just the loonie versus the greenback. It’s a different story when you compare the Canadian dollar to other currencies.

Although the Canadian dollar has been losing ground relative to the U.S. dollar, it has been relatively unchanged compared to the euro, the pound or the yen, explains Mitchell. “For the past six months, there’s been very little distinguishing one currency from another; they’re all really reflecting the performance of the greenback”, he says. “It’s very unusual for currency markets to be in such tight ranges.” While there are still differences between the loonie and other major currency markets, the fact that those fluctuations are more muted relative to the U.S. dollar means the exchange rate will have less of an impact on your returns if you have investments in Europe or Japan.

How a weaker loonie can boost your returns

Although the loonie is holding its own against other world currencies, the U.S. dollar is the foreign currency that’s commonly part of many Canadian investor portfolios. Unquestionably, the U.S. is still the top destination for Canadian capital, with more than two-thirds of the $361 billion Canadians snapped up in foreign securities heading south over the 49th parallel between 2020 and 2024.¹

For some time now, if you’ve been loading up on U.S. dollar investments, the exchange rate has worked to your advantage as the loonie has fallen in value versus the greenback. “Canadian investors need to appreciate that they’ve gotten a huge lift out of the currency,” says Mitchell. That’s especially true for investors who bought U.S. dollars in 2013, the last time the loonie was at par with the greenback.

Consider this: say you invested $5,000 in a U.S. dollar investment in 2013 which compounded annually at 5 per cent. Some 12 years later, that investment would be worth approximately US$8,979, but when you convert that investment back to loonies, it jumps up to $13,005. In essence, the exchange rate would account for about half of the return.

*Based on the Bank of Canada closing U.S.-Canadian dollar exchange rate on January 31, 2025 ($1.4484). Assumes initial investment was made at par on January 31, 2013 with all proceeds being reinvested annually.

Of course, the opposite is true, too. Should the U.S. dollar weaken, it could be a huge drag on your portfolio, wiping out much of your gains. That’s a real risk, says Mitchell.

Developing a currency risk strategy

While a Canadian dollar that’s weaker than it’s U.S. counterpart could benefit Canadian investors who hold assets in USD, it might be a good idea to find ways to manage the potential currency risk. The loonie is not likely to fall forever and if this trend reverses it could quickly undo some of the gains these investors have enjoyed. But that doesn’t mean you need to alter the mix of stocks and bonds in your portfolio, explains Mitchell. “Currency exposure shouldn’t dominate the asset allocation decision,” he says.

You could consider options and tools for hedging your exposure instead – especially if you feel a foreign-currency asset you have in your portfolio is overvalued relative to the loonie. While currency-hedged mutual funds and ETFs have been around for more than a decade, they were largely limited to a handful of options. Today, the universe of currency hedged mutual funds and ETFs continues to expand, giving investors greater flexibility to maintain their asset allocation while minimizing the currency effect, he explains. Increasingly, you can find a currency-hedged version of a fund you may already hold in your portfolio.

Putting hedges in place to offset individual holdings is a different matter. Mutual funds and ETFs have an advantage here, explains Mitchell. Hedging can be a very active process that involves monitoring several risks, he notes.

Funds also have a cost advantage over trying to devise hedges on your own. Mitchell explains it this way: when you go to the airport and want to convert your money into euros, you’re going to pay more because you’re converting a tiny amount. The company you’re working with has to cover all the overhead – the teller, the location – and maintain cash on hand that’s not earning interest. Institutional investors trade large volumes, so they get a better exchange rate. “For individual investors to try to do this hedging on their own would be quite challenging,” says Mitchell. “It’s not practical.”

If you decide to hold assets that are priced in a currency other than the Canadian dollar, you need to be mindful of potential exchange rates and fees. If you’re selling an asset in U.S. dollars and expect to reinvest those funds in another U.S. dollar asset, then you might want to consider using a U.S. dollar account to minimize your exchange fees, suggests Mitchell. “There’s no sense in getting dinged twice if you intend to redeploy that cash,” he says. Some brokers, including RBC Direct Investing, include a USD side to their accounts at no additional charge, but it’s important to check that your broker has this capability.

Other market risks should also be considered, as they can affect your portfolio regardless of currency.

Watch the trends

Regardless of how frequently you trade assets in a foreign currency, don’t overlook the impact the exchange rate can have on your return. With the loonie testing multi-decade lows, Mitchell notes it’s important to know that currencies tend to cycle over time.

Given that the Canadian dollar is very cheap next to the greenback, investors need to consider whether it has much more room to fall and weigh that against the risk to their U.S.-dollar holdings if the loonie starts to strengthen. “It’s always been important for investors to consider exchange rates, but it is certainly important right now.”

Sources
¹ _{Statistics Canada, "Canada's international transactions in securities, December 2024", December 2024}