You Need to Own U.S. Stocks – Here’s Why

This week’s edition of Take Stock is here….check it out!

The Motley Fool

Take Stock is the Motley Fool Canada’s free investing newsletter.  To have future editions delivered directly to you, simply click here now

Dear Fellow Fools,

We Canadians are a patriotic bunch. And for good reason! Can you think of a better country in the world to live? I know I can’t.

But our patriotic nature occasionally blinds us from opportunity – a fact that is glaringly apparent in the world of investing.

You see, Canadian investors tend to be drawn to Canadian stocks. This is fine, to a point. The problem is, many of us go beyond that point. The Canadian market equates to just 3.5% of the global stock market … yet raise your hand if you have more than 70% of your equity portfolio tied to Canadian stocks. I suspect more than a few of you have your hands in the air.

Yes, Canada has produced its fair share of great companies over the years, and tremendous opportunities to profit are out there right now; however, there are even more great companies and more tremendous opportunities outside of Canada’s relatively constricted investment borders. And the best part is, we don’t even have to look very far. After all, the deepest stock market in the world lies just to our south!

In this week’s Take Stock we’re going to present three reasons why we Canadian Fools think all Canadian investors should have a considerable allocation to both Canadian and non-Canadian (namely, U.S.) stocks in their investment portfolios. We’ll also take into account a couple of considerations as to why it doesn’t make sense to completely leave our fair market behind.

1. Selection

Perhaps the best reason to reduce your exposure to Canadian stocks by diversifying into the U.S. is the makeup of the two markets. Financials, Energy, and Materials stocks account for more than 70% of the Canadian market – as represented by the S&P/TSX Composite Index. Therefore, if you’re predominantly investing in Canadian stocks, there’s a very good chance you’re heavily exposed to these three sectors.

In contrast, the top three sectors in the U.S. market, as represented by the S&P 500, only represent about 46% of its total market capitalization. And two of the top three essentially have no representation in the Canadian market: Information Technology carries the heaviest weight in the U.S. market, while Healthcare carries the third heaviest.

By simply casting your investment lines south of the 49th parallel, you’re opening yourself to a much wider range of viable investment opportunities across all of the market’s sectors. The Canadian market has world-class companies in some sectors, whereas the U.S. is strong in others. Combined, they offer investors an excellent chance to build a well-diversified and highly effective portfolio.

2. Opportunity

This morning, I woke up with the help of the alarm on my Apple phone, washed my hair (what’s left of it!) with a Procter & Gamble shampoo, served the kids a bowl of General Mills cereal and am now writing this in Microsoft Word on a Dell computer that I acquired with a Visa credit card. A very high proportion of the products we use and consume in our day-to-day life come from the U.S.

One of the arguments that we hear about why Canadian investors remain so loyal to Canadian stocks is that we prefer to buy what we know. This fits if we’re talking about a bank or telecom product, but when it comes to consumer goods or health-care products, this argument doesn’t hold much water.

Just think of the well-known companies that Canadian-only investors would have missed out on in recent years – the aforementioned Apple and Visa are prime examples but the list literally goes on for pages. The U.S. economy is home to a disproportionate share of the greatest companies in the world. To give yourself the opportunity to find these companies before the rest of the world does, you need to start shopping in the right store.

3. Global reach

Not only do we Canadians recognize U.S.-originated products, but so too does the rest of the world. The U.S. is filled with multinational corporations whose fortunes are tied to the ebb and flow of the global economy. By investing in these multinationals, we too are gaining this global exposure in our portfolios.

Now, Canada’s resource-related stocks are definitely tied to the global commodities market, but you pay for this exposure in terms of volatility. And there are no doubt a number of individual companies in the Canadian market that have done a good job of developing an international business – our first two TSX-listed recommendations in Stock Advisor Canada are prime examples.

However, the number of Canadian companies with a significant worldwide footprint pales in comparison to the global exposure you get by investing in the U.S. market. Therefore, you’re not just diversifying from one economy (Canada) to another by investing in the U.S. In fact, you’ll gain much more in terms of global exposure by making this shift.

Before you start dumping your Canadian stocks, though, there are two frictional caveats to consider:

Consideration #1: Foreign exchange

Most of us live our lives in a Canadian dollar-based world. To acquire U.S. stocks requires U.S. dollars, adding an element of exchange-rate risk.

With the Canadian dollar trading right around par with the U.S. dollar at the moment, we don’t really see this as much of a risk at all. Sure, the Canadian dollar could appreciate against the greenback, thus eating into the returns provided by your U.S. stocks. But in our mind, the potential returns that are available by making this move into U.S. stocks far outweigh the impact that an adverse currency move may have.

Consideration #2: Dividend taxation

Whereas currency moves are anybody’s guess, the issue with dividend taxation is more concrete. Canadians receive a dividend credit (explained in more detail here) that reduces the tax burden we would otherwise face on these payments. This credit, however, only applies to Canadian corporate dividends. U.S. dividends are taxed as income – that is, at a higher rate, in non-registered accounts.

In addition, also in non-registered accounts, you’ll face a 15% U.S. withholding tax on a U.S. dividend payment. Rather than receiving a dividend cheque for $1.00, you’ll only receive $0.85. This can obviously impact your realized yield.

You can avoid this whole dividend tax situation by holding U.S. dividend payers in a retirement account such as an RRSP, RRIF, or LIRA. This same tax break does not apply in an RESP or TFSA. (As always, these are general points — consult your tax advisor for more specific information tailored to your individual situation.)

These registered retirement accounts — which receive relatively preferential tax treatment on U.S. dividends — represent a sizeable portion of Canadian’s savings. As a result, the issue with dividend tax is almost neutralized and doesn’t stand up as a great reason not to go cross-border shopping for stocks.

If you’re concerned about this dividend tax situation, it’s easy to mitigate: stash U.S. dividend payers in your registered retirement account and keep the non-dividend payers outside.

The Foolish Bottom Line

In our mind, the three benefits to allocating a reasonable chunk of your portfolio to the U.S. market far outweigh the frictional issues. And this is why in our Stock Advisor Canada service we’ve elected to provide members with two recommended stocks each month – one TSX-listed and one U.S.-listed.

Between our Foolish Canadian-domiciled investment team and the Fool’s U.S.-focused analytical firepower, housed at Global HQ in Alexandria, Va., we think we’re uniquely positioned to offer Canadian investors the best of both worlds.

Ask a Fool

We love hearing from our community of Fools and want to remind you that you can utilize our “Ask a Fool” service to put forward whatever might be on your mind. Simply e-mail us at [email protected].

And be sure to follow us on Twitter and Facebook for the latest in Foolish investing.

‘Til next time … happy investing and Fool on!

Sincerely,

Iain Butler

Chief Investment Advisor

Motley Fool Canada

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing

Payday ringed on a calendar
Dividend Stocks

3 Top TSX Passive-Income Stocks That Pay Out Every Month

Here are some of the best TSX stocks for passive monthly income. Investors should explore to see if they're a…

Read more »

edit Sale sign, value, discount
Dividend Stocks

3 Remarkably Cheap TSX Stocks to Buy Right Now

These three cheap TSX stocks are some of the best buys on the TSX, and yet their share price is…

Read more »

think thought consider
Dividend Stocks

This Dividend Stock Could Create $1,353 in Passive Income in 2024

This dividend stock can create massive passive income from two sources, so don't miss out before a recovery in 2024!

Read more »

Increasing yield
Dividend Stocks

TFSA Investors: Buy This Top Bank Stock for High-Yielding Dividends

Generate a superior passive-income stream by investing in this high-yielding dividend stock from Canada’s Big Six banks.

Read more »

grow money, wealth build
Dividend Stocks

2 of the Best TSX Dividend Stocks I Plan on Holding Forever

High-yield TSX dividend stocks, such as Enbridge, offer you tasty yields and trade at significant discounts to consensus price targets.

Read more »

FREIGHT TRAIN
Investing

CNR Stock: Should You Buy Today?

Canadian National Railway has been hit in recent quarters, as economic growth has slowed, with CNR stock declining 10% in…

Read more »

Family relationship with bond and care
Dividend Stocks

TFSA Investors: 3 Cheap Canadian Stocks for Retirees

These three Canadian stocks are super cheap for retirees looking for a great buy that will last the test of…

Read more »

calculate and analyze stock
Dividend Stocks

CPP Disability Benefits: Here’s How Much You Could Get

Not everybody can get CPP disability benefits. If you want some passive income, consider investing in Royal Bank of Canada…

Read more »