Why it’s Not Enough to Buy the S&P/TSX Composite Index

If you’re only invested in the Canadian market, you should re-analyze your portfolio. S&P/TSX Composite Index (TSX:^OSTPX) gives a clue to the problem.

Kay Ng

Author Bio

Kay graduated from the University of British Columbia with a Bachelor of Science in Computer Science and furthered her studies in financial markets, finance, and financial accounting. She began investing in dividend stocks in 2008, turning an early interest into a lasting passion. Over the years, Kay has refined her investment approach to focus on high-quality businesses, using fundamental analysis and valuation to identify long-term investment opportunities. Her investment research and articles have been featured in The Motley Fool, Sure Dividend, and Seeking Alpha. Outside of investing, Kay enjoys playing the piano, from popular songs learned by ear to challenging classical compositions. Her favourites include Fantaisie-Impromptu by Frédéric Chopin and La Campanella by Franz Liszt.

Education

Bachelor of Science (BSc) in Computer Science, University of British Columbia Further studies in financial markets, finance, and financial accounting

Areas of Expertise

Dividend stocks, fundamental analysis, company valuation, quality investing, long-term investing, business fundamentals, and identifying investment opportunities in high-quality companies.

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Favorite Investment Quotes

“The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.” — Benjamin Graham “A market downturn doesn’t bother us. It is an opportunity to increase our ownership of great companies with great management at good prices.” — Warren Buffett

Published May 18, 2017 8:19 am EDT

think, plan, and act to work towards your financial goals

When Warren Buffett said that investors should stick with index funds, he didn’t mean to buy just any fund and be done with it. It wouldn’t do to only invest in a fund that replicates the S&P/TSX Composite Index (TSX:^OSTPX) (i.e., the Canadian market).

Here’s why.

The index is concentrated in three sectors with an almost 69% weighting: financials (35.4%), energy (21.4%), and materials (12.1%). That’s not nearly sufficiently diversified.

The index lacks greatly in consumer staples (4% of weighting), utilities (3%), information technology (3%), and healthcare (0.6%). Consumer staples and utilities have tended to deliver stable returns with reduced volatility, dividends, and dividend growth.

Information technology has been an area for tremendous growth. The healthcare sector in general benefits from the megatrend of an aging population.

So, it does not make sense to have little exposure to consumer staples, utilities, information technology, and healthcare.

If you are invested in the S&P/TSX Composite Index, you can increase your exposure to consumer staples, utilities, information technology, and healthcare by investing in other index funds or by investing in selective stocks in each sector.

Tech stocks for growth

In the information technology sector, we can look to the south of the border for a stock such as Facebook Inc. (NASDAQ:FB).

It still looks reasonably valued for double-digit growth potential, despite the shares trading near their all-time high.

Facebook will continue to benefit from the network effects of its growing global user base and the increasing spending on online and mobile advertising from its clients.

In Canada, we also have some technology stocks, including Shopify Inc. (TSX: SHOP)(NYSE:SHOP), which provides a cloud-based, multi-channel commerce platform targeted at small- and medium-sized businesses, and Sierra Wireless, Inc. (TSX: SW)(NASDAQ: SWIR) which is involved with the Internet of Things.

Both companies have had strong revenue growth. Shopify and Sierra Wireless have increased their revenues at a compound annual growth rate (CAGR) of 100% and 11.6%, respectively, in the last four years. Compare that to Facebook, which has increased its revenue at a CAGR of 52.6% in that period.

Ensure your portfolio is sufficiently diversified

If investors want to keep it really simple and invest in only one index fund, they can opt to invest in SPDR S&P 500 ETF Trust (NYSEARCA:SPY), which is well diversified.

The index fund seeks to replicate the performance of the S&P 500 Index, which is a market capitalization-weighted index of the 500 largest companies that are publicly traded in the U.S.

Currently, the index has weightings of about 22.9% in information technology, 14% in financials, 13.8% in healthcare, 12.3% in consumer discretionary, 10% in industrials, 9.2% in consumer staples, and 2.8-6.2% in energy, utilities, real estate, and materials.

This is much more diversified than investing in a fund that replicates the S&P/TSX Composite Index. In any case, if you’re investing in funds, dollar-cost averaging over time is a good strategy. It takes away the emotions of greed and fear, which often deter investors from making the right investment decisions.