The hidden cost of currency conversions

When you’re trading international stocks, it’s not only the charge for buying the shares that matter. The charge for buying the foreign currency the shares are quoted in can also be very significant.

At some stock brokers, this FX commission can be higher than the commission on stocks. And many brokers try to make their rates look better by hiding it deep in the small print or even not mentioning it at all.

This is particularly a problem in the UK, although investors everywhere should watch out for it. For example, take TD Direct Investing (formerly TD Waterhouse UK). It charges a standard rate of £12.50 per trade for international stocks. On an investment of £1,000, that’s a commission of 1.25%. But TD Direct will also charge up to 2% over the interbank rate for converting your currency – almost twice the headline stock commission.

To be fair to TD Direct, it displays its currency charges more clearly than many rivals. But while they may be transparent, they’re certainly not trivial. Charges like that will mount up pretty quickly, especially if you’re an active trader. So minimising your FX commissions is an important part of keeping your costs down and improving returns.

Three ways to buy foreign stocks

To do this, you need to know something about the way in which stock brokers handle international trades and the associated currency conversions. There are three main approaches:

  • Buy the shares directly in the overseas market in foreign currency and allow you to hold and settle in the foreign currency
  • Buy the shares directly in the overseas market in foreign currency, but only allow you to hold and settle in your home currency
  • Buy the shares through market makers or other intermediaries who quote your broker a price in your home currency

Clearly, the first approach gives you the most transparent pricing and control over how you hold your assets. You can see what FX rate you got and you can choose to whether to convert sales proceeds back to your home currency or keep them in foreign currency.

The second gives you no control over the conversion of your cash. But it should be obvious what FX commission your broker is charging you – and they should certainly be able to tell you, even if they don’t advertise it.

The third gives you no control and little transparency, because the FX conversion cost is being embedded in the price quoted by the marker maker, rather than being an explicit fee from your broker. However, from the price you pay, the stock price in the foreign currency and the FX rate, you can work out roughly what extra costs you are paying.

Be aware that – at least in the UK – some stock brokers may get partial rebates out of the FX mark-up from some market makers. This is a hidden commission to them and will increase the cost to you if the market maker pushes up the FX mark-up to compensate. Hargreaves Lansdown and Selftrade are among these firms.

These different approaches make finding the cheapest broker difficult, since the answer will depend on how you plan to trade. For example, assume you have a broker that charges 1% to convert from GBP to EUR, but allows you to hold EUR in the account. A second one allows you to hold GBP only in your account, but charges 0.25% per conversion. All else being equal, if you plan to trade in and out of EUR-denominated shares more than four times before converting the EUR back to GBP, the first broker – with the higher conversion cost – will still work out cheaper than the second one.

Once you factor in commissions, custody fees, other costs, minimum account sizes and non-cash considerations such as good customer service, a stable trading platform and the range of markets available, no single broker stands out as best for everyone. For infrequent traders, lower FX commissions may be less important than the multi-currency account. For more active ones, the ability to avoid having to convert currency on every trade may outweigh the higher commission.

Obviously, low FX commission costs and a multi-currency account is the best of both worlds – but not many brokers offer that. It’s worth being aware that brokers that operate multi-currency accounts but have high FX commissions may allow you to make transfers in foreign currencies as well as your home currency. With these firms, you may be able to save on FX costs by passing your payment through a currency transfer specialist for conversion.

UK brokers’ FX commissions compared

The table below shows the FX conversion cost and execution model for some of the main UK discount brokers. MM-GBP represents a broker trading through a market maker with settlement in GBP, D-GBP is a broker that trades directly in the overseas market with settlement in GBP and D-FX is a broker that trades directly in the overseas market and allows cash holdings and settlement in foreign currency.

To show how much difference FX and other commissions can make, the table also compares the estimated costs from a year of trading for A) an investor who buys and holds £1,000 worth of US equities per month, B) an investor who buys and then sells £1,000 worth of US equities in alternate months and C) an investor who buys £12,000 worth of US equities in a single trade. (In other words, all three involve a total of £12,000 traded during the year, but in very different ways.)

Trading and settlementFX commissionTrade ATrade BTrade C
Alliance TrustMM-GBP1.3%£648£637£208
Barclays Stockbrokers*D-FX1.5%£335£170£229
Halifax Share Dealing**D-GBP1%£263£263£132
Hargreaves LansdownMM-GBPUp to 1.7%£347£347£192
iDealing***MM-GBPAround 0.5% for smaller deals, 0.25% or less for larger£199£199£90
Interactive BrokersD-FX0.01% (min US$2.5) plus market spread£77£77£77
Saxo BankD-FX0.5%£174£119£74
SelftradeMM-GBPUp to 1.25%£330£330£205
TD Direct Investing****D-FXUp to 2%£390£170£253

*Barclays Stockbrokers allows clients to hold and settle in GBP, USD and EUR. For stocks settling in other currencies, trade B would require currency conversion each time, suggesting an approximate cost of £335.

**Halifax Share Dealing also operates the iWeb and Motley Fool stock broking services. The trading fees vary slightly – iWeb is cheaper, Motley Fool is more expensive – but the FX commission is the same for all, at 1%.

***iDealing example assumes GBP settlement. The firm adds no margin to the FX mark-up included by market makers – a typical margin seems to be around 0.5% for smaller deals and 0.25% for larger ones. iDealing also allows several other currencies to be held and used for settlement where a non-GBP quote is available – conversions of cash balances within the account carry a 1% commission. This may be most cost-effective for frequent traders in instruments quoted in a given currency.

****TD Waterhouse also operates the NatWest Stockbrokers, which has higher trading fees but the same FX charges. Both TD Direct and NatWest allow inbound transfers in foreign currencies, which could reduce these costs.

For more details of these brokers and others, see the UK international stock brokers comparison table.

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