The U.S. Dollar is Falling: Should Canadian Investors Buy Currency Hedged ETFs?

Confidence in the U.S. dollar continues to erode. Over the trailing one-year period, the U.S. Dollar Index (DXY), which measures the dollar against a basket of major foreign currencies, is down 10.46%.

That move comes after a much longer trend of declining U.S. dollar reserve usage globally, alongside a fresh wave of geopolitical stress that has caused investors to question the stability of U.S. monetary and political institutions.

Recent developments have only added fuel to that narrative. Immigration crackdowns have sparked domestic unrest within the United States, while relations with long-standing allies have deteriorated amid President Donald Trump’s on-again, off-again tariff threats and broader foreign policy uncertainty. Taken together, it is not surprising that the dollar has come under sustained pressure.

Against that backdrop, a question I am hearing more often from Canadian investors is whether now is the time to switch their U.S. equity exposure into currency-hedged ETFs. Canadian investors buying U.S. stocks through Canadian-listed ETFs are typically given that choice: remain unhedged and accept currency fluctuations, or hedge the currency exposure back to Canadian dollars.

My long-standing stance has been to remain unhedged. That has not changed. Still, it is worth walking through how currency hedging actually works, why it can look attractive during periods of U.S. dollar weakness, and why I ultimately think the costs outweigh the benefits over the long run.

How Currency Hedging Works

To make this concrete, consider two Canadian-listed Vanguard S&P 500 ETFs.

The first is Vanguard S&P 500 Index ETF (VFV). It charges a 0.09% expense ratio and tracks the S&P 500 by holding VOO, the U.S.-listed version of the same index. Dividends are subject to the standard 15% U.S. withholding tax. VFV is not currency hedged.

Because VFV is unhedged, its returns reflect two components: the performance of the S&P 500 and movements in the U.S. dollar relative to the Canadian dollar.

All else equal, when the U.S. dollar strengthens, VFV tends to outperform the underlying S&P 500 index in Canadian-dollar terms, because each U.S. dollar of equity value converts into more Canadian dollars. When the U.S. dollar weakens, the opposite happens. The same U.S. equity gains translate into fewer Canadian dollars, creating a headwind.

This currency effect can either help or hurt returns, but either way it adds an additional layer of volatility. It also explains why investors sometimes see VFV moving differently from the S&P 500 on a given day. Intraday currency fluctuations can overwhelm equity moves, especially when markets are choppy.

The alternative is Vanguard S&P 500 Index ETF (CAD-Hedged) (VSP). VSP also holds VOO, also pays the same withholding tax on dividends, and also charges a 0.09% expense ratio.

The difference is that VSP includes a currency hedge designed to neutralize fluctuations between the U.S. dollar and the Canadian dollar.

In theory, that means if the U.S. dollar strengthens, VSP will not benefit. If the U.S. dollar weakens, VSP will not suffer the same drag as VFV. On the surface, that sounds appealing. If your goal is to own U.S. stocks and not speculate on currencies, hedging appears to remove an unnecessary variable.

The problem is that the hedge itself is not free.

The Hidden Cost of Currency Hedging

To see this, it helps to look at total returns with dividends reinvested. If currency hedging worked cleanly, VSP’s performance should closely resemble that of VOO, minus a small drag from higher expenses and dividend withholding taxes. That is not what has happened.

Over the past 10 years, VOO delivered a cumulative return of 306.9%. Over the same period, VSP returned 269.4%. That represents a negative cumulative tracking error of roughly 37.5% over a decade.

In contrast, VFV returned 327.2% over the same period. A large part of that outperformance relative to VOO reflects the strength of the U.S. dollar over that decade, which acted as a tailwind for unhedged Canadian investors. But VFV also avoided the structural drag imposed by the currency hedge.

Both VFV and VSP charge the same stated 0.09% expense ratio. The difference is that VSP bears additional costs related to maintaining the hedge. Those costs do not show up neatly in the expense ratio, but they do show up in long-term performance. Over time, that drag compounds.

My view is that over multi-decade periods, currency pairs tend to ebb and flow. They move in cycles, overshoot, undershoot, and eventually regress toward long-term averages. Currency exposure adds volatility, but it also adds potential return. If you are patient, that volatility tends to wash out.

Choosing a hedged ETF like VSP removes that source of variability, but replaces it with a persistent, year-over-year performance drag that compounds negatively. That is a trade-off I am not willing to make.

If peace of mind matters more than long-term efficiency, VSP is a perfectly reasonable product. Just be clear-eyed about what that peace of mind has historically cost.