Have you ever tried to convert your Canadian dollars (CAD) into US dollars (USD) or the other way around? You may have noticed the exorbitant fee that is charged to you on top of the exchange rate.
Most banks or brokerages are either charging you a fee directly or a spread that amounts to 1.5% to 2% of the total amount. If you are converting $10,000, that transaction can cost put to $200!
Luckily for us, there is a much more cost effective way to get around these fees using a technique called the Norbert's Gambit.
In the simplest form, you are buying an inter-listed stock or ticker (a stock or ticker listed on both the US and Canadian exchanges) in your initial currency CAD. Then request for the stock to be sold and settled in your desired currency USD.
When you use this little trick, instead of paying a percentage fee on the amount of money you would like to convert, you will pay a fixed transaction fee on two trades.
Assume if the cost to do a trade is $10 CAD, instead of paying 2% or $300 to convert $15,000 into USD, you now only pay $20 after making these two trades. That is a 90% savings! And the more you are converting the more you are effectively saving on transaction costs.
BUT THERE ARE A FEW CAVEATS TO BE AWARE OF!
The most general risk factor that you need to be aware of when using the Norbert Gambit is that you are buying a volatile asset. This means that the stock price can fluctuate between the time you buy the stock in CAD and the time it takes for you to sell and settled it in USD.
The time it takes to settle will vary depending on which brokerage you are using. You may be exposed to a few days of price fluctuation before you can get your USD.
Let's take the example of the TD Bank stock (TD:TSE is the Canadian ticker listed on the Toronto Stock Exchange and TD:NYSE is the US ticker listed on the New York Stock Exchange). The current price of TD (as of this writing) is about $75 CAD or $60 USD with an exchange rate of 1.25:
This $2,000 USD in price fluctuation is far costlier than the 2% or $300 CAD ($240 USD) in transaction fees by doing a direct conversion. But on the other hand, you can just as easily see the stock price increase by the same amount too and 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!
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:
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.
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.
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:
It is important to note that a bid-ask spread on 1 cent on a $10 stock is actually more expensive than a bid-ask spread of 1 cent on a $75 highly liquid interlisted stock such as TD.
Ultimately, if you are exchanging a large amount of funds with one of the major banks, it is beneficial to try this technique to save a bit on fees. It is also important to recognize the services your brokerage is offering and to understand the risks of using this technique.
While major banks may have a bid-ask spread of 1%-2% on currency conversions, a discount brokerage such as Interactive Brokers offers CAD/USD exchanges for a tiny 0.2 basis points (or 0.002%) fee at a minimum of $2 USD. This means that if you are exchanging the same $15,000 CAD to USD, you are only paying $2 USD of fees. At this price, there is no reason you use Norbert's Gambit as the transaction fees of buying stocks will cost you more!