Avoid Expensive Currency Exchange Fees With Norbert's Gambit

Have you ever tried to convert your Canadian dollars (CAD) into US dollars (USD) or vice versa? You may have noticed the exorbitant fees that is charged to you on top of the exchange rate.

Most banks are either charging you a direct fee or a spread that amounts to 1.5% to 2% of the amount you want to exchange. If you are converting $10,000, that transaction can cost you up to $200!

Luckily for us, there is a technique to get around these pesky fees by using what is called the Norbert's Gambit.

What Is Norbert's Gambit?

In the simplest form, you are using your brokerage to convert the currency a stock is quoted with instead of converting your cash directly.

The technique would be to buy a stock or ticker (listed on both the US and Canadian exchanges) from your brokerage in your initial currency. Then request for the stock to be sold and settled in your desired currency.

Why Use Norbert's Gambit?

When using the Norbert's Gambit, you avoid the need to pay a percentage of the money you would like to convert. Instead your costs will only be limited to two transaction fees, on the buy and sell.

Assume you want to convert $15,000 into USD and the cost of a trade is $10 CAD. Instead of a paying 2% spread (or $300), it will only cost $20 to perform the Norbert's Gambit. That is more than 90% savings! And the more you are converting the more you are saving on transaction costs.

BUT THERE ARE A FEW CAVEATS TO BE AWARE OF!

Risk Factors Of Norbert's Gambit

1. Price Volatility

One major risk factor you should be aware of when using the Norbert Gambit is that you are buying a volatile asset. Stock prices can fluctuate between when you buy the stock in CAD and when you to sell it in USD.

The two transactions are also not simultaneous as you need to wait the settlement period. The time it takes to settle varies depending on the brokerage you are using. As a result, you will be exposed to a few days of price fluctuation.

Let's take the example using a random stock with ticker ABC. Assume the price of ABC is $75 CAD and the exchange rate is 1.25. The USD price will be $60:

• If you had $15,000 CAD and buy 200 shares of ABC, then convert it to USD which nets you $12,000 USD with $20 of transaction costs
• But let's say it takes an entire day to settle and the price fluctuates from $60 USD to $50 USD. Now you would only receive $10,000 USD, costing you an extra $2,000 USD

This $2,000 USD due to price fluctuation is far costlier than the 2% spreads charged when doing a direct currency conversion. On the flip side, the stock price can just as easily increase where pocket an extra $2,000 USD. This is a risk you would assume when using the Norbert's Gambit.

But wait! There are ways to remove this risk which I will go through later on!

2. Bid-Ask Spread

The bid-ask spread of the stock you are trading is the next bigger risk factor or cost of using Nobert's Gambit. The price you buy a stock for will be higher than the price you sell the stock for if you are doing both simultaneously. The less liquid the stock, the wider the spread will be and more likely it is to fluctuate.

Imagine you are trading the same TD stock as the previous example with a mid price of $75 CAD or $60 USD:

• Assume if the bid-ask spread is $1 (or 50 cents from the mid price), then the ask price on the Canadian side is $75.50 to buy and the bid price on the USD side is $59.50 to sell.
• This means that you will need $15,100 CAD to purchase the same 200 shares and only be able to convert that into $11,900, costing you an extra $180 USD

A $1 difference spread on a $75 stock is a fairly large and with a liquid stock like TD, the spread is generally between 0.05% to 0.1% of your base amount (or under $15 to convert $15,000). As long as you are using a liquid stock, this is still much cheaper than paying the spreads to do a direct conversion.

3. Trade Execution Factors

Trade execution will vary by which brokerage you are using, so it is essential to understand the details. If you are unsure, please call to ask your brokerage directly before trying anything you don't understand.

Here are some key factors to look out for:

• Does your brokerage offer the service to settle inter-listed stocks in different currencies? And if so, there may be an additional fee attached to it.
• Some brokerages will require you to call in order to request to settle your holdings in a difference currency. Wait times, especially during busy periods should be a consideration.
• Take note of the settlement periods. It may take a few days before your request to convert the shares from one currency to another is processed. During that time period, you are exposed to the stock price volatility

Using DLR/DLR-U For Norbert's Gambit

Alternative to using an interlisted stock, there exists an ETF called the Horizons US Dollar Currency ETF which trades on the Toronto Stock Exchange. This ETF trades in two tickers, DLR which trades in CAD and DLR-U which trades in USD.

DLR and DLR-U tracks the USD/CAD exchange rate where the price of the ticker floats around $10 USD per share. By using DLR/DLR-U for Norbert's Gambit, you would effectively eliminate the risk of price fluctuations:

1. With $15,000 CAD you would buy 1,200 shares of DLR if they are $12.50 CAD each.
2. Then you will call your brokerage and ask them to convert them to DLR-U. You would now have 1,200 shares of DLR-U which are valued at $10 USD.
3. Sell your 1,200 shares of DLR-U for $10 USD each and now you have $12,000 USD

It is important to note that a spread of 1 cent on a $10 stock is more expensive than the same spread on a $75 stock.

Is Using Norbert's Gambit Right For Me?

Ultimately, if you are exchanging large amounts of funds, it is beneficial to use the Norbert's Gambit. It is important to recognize the services your brokerage is offering and to understand the risks of using this technique.

Large banks might likely charge a spread of 1% or 2% on currency conversions. A discount brokerage on the other hand may offer much more favorable rates.

Interactive Brokers offers CAD/USD exchanges for 0.2bp (or 0.002%) with a minimum of a $2 USD charge. This means that if you are exchanging the same $15,000 CAD to USD, you are only paying $2 USD of fees. At this rate, there is no reason to use Norbert's Gambit as the transaction fees of buying stocks will cost you more!