When stock markets are undervalued, it’s usually a good time to invest aggressively in the index offerings that track them. When market valuations rise, however, a more circumspect approach is better.
Recently, the U.S. stock market, as represented by the S&P 500 Index, dropped by more than three per cent in a sell-off that was triggered by a number of factors, including weak European economic data, Argentina’s debt default and disappointing U.S. corporate profits. Time will tell whether this recent trend will turn out to be a full-blown correction.
In the meantime, we see no reason to aggressively plunge into exchange-traded funds, or ETFs, that track the U.S. stock market now. That includes iShares S&P 500 Index ETF (TSX-XUS), which is one of the recommended offerings in our quarterly ETF Special Report.
With the modest setback the S&P 500 has experienced so far, the Index remains fairly valued, in our view, trading as it does at just over 16 times the earnings it’s expected to post in 2014. For investors of modest means, therefore, we would prefer to see a more substantial correction before buying, say, a board lot of the iShares S&P 500 Index ETF.
What the small investor should do
If you’re a small investor, you would be better off committing sums that are more affordable for you, such as $100 a month, to an index mutual fund like TD U.S. Index Fund-e (TDB902 (NL)). That way, should markets continue to correct, you would be able to purchase more units at a lower price.
This investment approach is known as dollar-cost averaging. By investing fixed sums at regular intervals, it lets you buy more units of a fund when the price is low and fewer when the price is high. This way, you get an average cost that’s lower per unit than the average price of the units.
If you have large sums to invest on a regular basis, iShares S&P 500 Index ETF might be your better choice. The ETF’s management expense ratio, or MER, after all, is just 0.10 per cent. By contrast, TD U.S. Index Fund-e comes with a higher MER — 0.35 per cent. A drawback of investing in ETFs, of course, is the commissions you’ll pay to buy and sell their shares.
If you’re an investor of more modest means, on the other hand, index mutual funds let you avoid these commissions, which are uneconomical when you have just small amounts to invest. Then too, mutual funds make it easy to invest constant amounts by issuing fractional shares.
Whichever way you choose to do your index investing, through ETFs or index mutual funds, we strongly recommend a program of regular investing as the surest, most painless route to a secure retirement.
Canadian Mutual Fund Adviser, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846