How to keep costs low when trading internationally

It’s useful to think of trade costs, particularly brokerage fees and currency conversion costs, in the same way we think of compounding returns, by Charu Chanana

The more affordable your broker’s pricing schedule for brokerage and currency conversion (i.e., the total cost of trade), the more you can save as the size of a particular trade increases – meaning what appears to be a fractional saving in trade costs can ultimately save you thousands in dollars and cents.

Indeed, while brokerage fees for popular equity markets such as the US NASDAQ or New York Stock Exchange (NYSE) tend to garner the most attention with retail equity investors, it’s often currency conversion that makes the biggest difference when trading internationally.

Breaking down the numbers: a trade scenario

Take a scenario in which an Australian-based investor, with a “home” currency of AUD, wishes to purchase an equity on the US NASDAQ which costs USD 50.

Let’s say the investor has a choice between two investment brokers – one which charges a 0.25% FX mark-up as its currency conversion fee, and another which charges 0.45% FX mark-up as its currency conversion fee. This means that a 0.25% or 0.45% mark-up is applied to the prevailing exchange rate – the FX spot mid-price. For the sake of simplicity and illustration, let’s say the FX spot mid-price for AUD/USD in this scenario is a flat 0.70000.

A 0.25% FX mark-up on a 0.70000 AUD/USD spot mid-price will result in an exchange rate for the investor of 0.69825, while a 0.45% FX mark-up on a 0.70000 AUD/USD spot mid-price will result in an exchange rate for the investor of 0.69685.

The difference? A paltry 0.00140 – or so it appears.

This means that for every AUD 1 the investor converts to USD, they’ll get to keep USD 0.0014 more by selecting the broker with a 0.25% FX mark-up as its currency conversion fee.

If the investor converted AUD 100 to USD, they’d be USD 0.14 better off – not that much. But as the AUD sum for conversion to USD climbs, so the savings build up, and fast. By the time they’re seeking to transfer AUD 80,000 to USD, the saving has risen to USD 112.

Presuming brokerage costs for US equities at the two investment brokers are equal (in this scenario, 0.03% of the overall trade value), the investor can either save USD 112 or buy two additional USD 50 equities with the same sum of AUD. Should the investment broker with the cheaper currency conversion costs also offer a cheaper brokerage fee per trade, these benefits become even larger, as the investor saves on both FX and brokerage.

That means more compounding benefits and more dividends – boosting the investor’s overall returns and helping them achieve their long-term investing goals.

It’s important to note that this positive outcome for the investor is underpinned by their ability to trade with a broker that offers multi-currency sub-accounts/“wallets”. Through global brokers such as Saxo, investors can hold multiple currencies simultaneously with “sub-accounts” under a single account structure – in Saxo’s case, investors can hold sub-accounts in 11 different currencies (with a maximum of four sub-accounts). In this way, the investor can move lump sums between their currency sub-accounts – as the investor in our scenario has done from AUD to USD – and conduct all trading within the relevant sub-account, without attracting FX fees for every trade in that foreign currency (or the receipt of dividends). With a USD balance in their USD sub-account, the investor will only pay brokerage on their US trades.

Supercharging portfolio diversification

Also keep in mind – this outcome stems from a single (albeit large) trade. Adding diversity to a portfolio through a selection of stocks across different sectors and markets has long been considered a way to lower risk, avoid unnecessary stress, and improve the likelihood of positive portfolio growth over the longer term. As noted by Nobel prize laureate Harry Markowitz, diversification is the only “free lunch” in investing.

Saxo research shows that, by blending a five-stock portfolio 50/50 with a broader equity market Exchange-Traded Fund (ETF), investors can significantly reduce their risk levels without sacrificing long-term expected returns.

And as investors build a diversified, “all-seasons” portfolio, their overall savings on international equity trades will only grow with the more affordable broker, enabling them to save more of their hard-earned money, put more of their money to work in the markets, or both. Consider it a way to “supercharge” portfolio diversification – and get a taste of that “free lunch”.