Hedging the Dollar

Winter 2001 CSANews Issue 41  |  Posted date : Apr 03, 2007.Back to list

Things have changed financially for Canadian snowbirds as at no time we have ever seen in the past. The Canadian dollar hit a record historical low against the $U.S., and interest rates on fixed-income investments are at 40-year lows. This has an impact on both income and our purchasing power.

Today, we need new answers to the old questions of how to hedge our dollar risk and how to realize a meaningful return, as fixed-income products such as savings bonds and GICs seem pointless options. Canada Savings Bonds yield 1.8% (after tax 1.2%) and inflation is running at approximately 2.5%, to produce a minus 1.3% return, and you pay tax each year on accrued interest you have not yet received.

We need answers, now!
  1. Speak to your investment advisor about Government of Canada Foreign Pay Bonds in U.S. dollars ­100% guaranteed and triple-A rated; their yield is far better and they're in $U.S., obviously better than a 0.1% U.S. dollar savings or chequing account. They also qualify as Canadian content for an RRIF.
  2. A Managed Yield mutual fund ­ money market in $U.S. It pays 0.8% above normal money market rates and it is treated as capital gains at half the tax ­ Mackenzie Financial is a good example.
  3. Income-based mutual funds ­ a number of funds pay out dividends and capital gains monthly at rates varying from 6-9%. This is regular cash flow and it's tax-efficient at lower tax rates than interest. Clarington and Manulife (Elliott & Page) are two good examples.
  4. Let's not forget annuities ­ prescribed and charitable. The cash flow is far superior to that of GICs, and more tax-efficient as well. Prescribed annuities for a 70-year-old will pay out about 10% after tax, cash, and approximately 15% for an 80-year-old. That's net to you. For example, a GIC today, after taxes, produces about 1.5% in a five-year term, versus 10% net cash in the annuity. This is created with your advisor and an insurance company. A charitable annuity for a 70-year-old pays about 7% tax-free cash to you along with a receipt for its residual value, today. This is an immediate tax saving and will provide both a charitable gift to charities of your choice upon your demise, and a tax savings so you can use it to shelter income such as additional RRSP/RRIF withdrawals, to make them tax-free. The annuity is created with your advisor and an insurance company to benefit the charity as part of your estate plans.
  5. Royalty income trusts from real estate, oil and gas, and mining provide a good cash flow despite lower resource prices. They should comprise no more than 5% of a portfolio, but they can help reduce overall portfolio risk. However, don't get oversold on these, as they do suffer from commodity fluctuations. The cash flow averages 8-14% payable quarterly.
A risk-managed approach is to buy a mutual fund diversified income trust that contains 10-20 different royalty trusts. Its cash flow will always be positive. Sentry Select and Dynamic both offer them.

Our approach for 2002 is to tread carefully. Interest rates will stay low with a slow-moving economy. The dollar has little upside above 63¢ U.S., unless there is a major corporate tax cut in Canada and a big turnaround in resources, wheat, oil and softwood lumber, which is not very likely.

The only pluses are cheap gas, lower costs for heating and bargains for air travel, hotels and new cars. But at least we have some new answers to the old questions that keep coming up.