In spite of a large body of evidence that investing in equities produces superior long-term results than does investing in any other class of assets such as bond, money-market securities or gold, investing in just a few stocks carries substantial risk. Exchange-traded index funds help lessen that risk.
We’ve always believed that equities outperform fixed-income investments over any long period of time, say 10 years. But equities comprise both winners and losers. The only way to be certain you get your share of both is to buy them all. What’s more, if a mutual fund were to do that, it wouldn’t need any research, or even a knowledgeable manager to do the stock selection. Management expenses would be low.
Stock markets and other interested organizations have, over the years, picked groups of stocks that seem to behave in aggregate nearly the same as the overall market. These groups are called indexes. Generally, the larger the index, the more closely it follows the entire market average. It’s certainly easier to buy the stocks in an index than all the stocks on the market. If the correlation between the index and the overall market is close, your investment portfolio should suffer no more risk than an investment in the whole market.
ETFs remove much of the stock-picking risk
If you believe in equities, but can’t stand the risk that you might pick a fund that performs relatively poorly, exchange-traded index funds may be for you.
The Money Reporter’s regular feature ‘Best Exchange-Traded Funds For You’ consists of 13 exchange-traded funds, or ETFs, that track various equity and bond indexes. They should be the main building blocks of your ETF portfolio.
In Toronto, we have the S&P/TSX 60, an index of just 60 stocks, and the S&P/TSX Composite, a much broader index of nearly 250 stocks. Both of these indexes track the overall market quite well, but not perfectly. The S&P/TSX 60 comprises primarily the 60 largest companies on the exchange. The S&P/TSX Composite includes these 60 largest companies, plus about 190 smaller ones.
At times large companies outperform small ones and vice versa. Right now, the 60 largest companies are slightly outperforming the 190 smaller ones.
iShares S&P/TSX 60 Index ETF (TSX—XIU) attempts to make its portfolio track the S&P/TSX 60 Index. That means it performs much like the index. It has a management expense ratio of 0.18 per cent, so it should produce net results slightly below the actual index’s total returns.
Over the past five years, the ETF has a compound annual growth rate of 8.0 per cent, ranking it in the second quartile of the Canadian equity category. The average fund in the category returned an annualized 7.7 per cent during that time. The average, of course, is comprised of relative winners and losers. Over the past year, the ETF gained 5.7 per cent, ranking in the top quartile. The average fund gained 4.3 per cent in the same period. The ETF’s current distribution yield is 2.8 per cent, so you receive some income as well as the potential for growth from the shares.
iShares S&P/TSX 60 is a buy for growth and some income if you’re comfortable with medium investment risk.
2 ETFs to buy for higher income
If you want a higher level of income from a Canadian index ETF, you might consider iShares S&P/TSX Canadian Dividend Aristocrats ETF (TSX—CDZ). It gives you diversified exposure to a portfolio of Canadian dividend-paying stocks. The underlying index screens for large established Canadian companies that have increased ordinary cash dividends every year for at least five consecutive years. The ETF pays a regular monthly dividend that yields 3.8 per cent a year. Buy for growth and income.
Another ETF to consider is iShares Core S&P/TSX Composite High Dividend ETF (TSX—XEI). It seeks long-term capital growth by trying to duplicate the performance of the S&P/TSX Composite High Dividend Index, less expenses. The ETF is more heavily focused on the financial and energy sectors than is the Dividend Aristocrats ETF. Like the Dividend Aristocrats fund, it also pays a monthly income. The distribution yield is currently 5.0 per cent. It’s a buy for income and some growth.
A word to the ‘cost-conscious’ wise
You should invest enough money in an ETF to justify the brokerage commissions you’ll pay to both buy and sell it on the stock exchange. Otherwise, a mutual index fund such as TD Canadian Index-e (Fund code: TDB900 (NL)) is more appropriate for small sums of money.
This is an edited version of an article that was originally published for subscribers in the September 1, 2017, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.
Money Reporter, MPL Communications Inc.
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