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Investors: 1 ETF You Should Avoid… Forever

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Exchange-traded funds (ETFs) are an excellent way to build a diverse, passively-managed, low-cost portfolio, which is the optimal solution for investors, as not everyone enjoys researching individual names or scanning earnings reports.

One of the issues with the ETF market is there’s a lot of competition out there. If you’re looking for a Canadian equity ETF, for instance, there are dozens of choices that are all pretty close to each other.

Sure, they’re all special in small way, similar to how all snowflakes are unique. But the end of the day, they have commonalities than differences.

While most ETFs are good products that allow investors an easy way to get exposure to a complex market, there is the odd ETF that I don’t think anyone should own. I’d like to profile one such ETF today — a product you can easily replicate on your own without paying what I view as an excessive fee. Let’s take a closer look.

Canada’s most unnecessary ETF?

The BMO Equal Weight Banks ETF (TSX:ZEB) owns an equal-sized position in the six largest Canadian banks. It starts out with a 16.6% weighting in each of Canada’s six largest financial institutions and rebalances the portfolio every so often to maintain the weighting.

The index hasn’t been rebalanced in a little while, so some of the weightings are a little bit off. The largest position is in National Bank of Canada, with an 18.32% position. The smallest, meanwhile, is in Bank of Nova Scotia, with a 15.58% position. The rest of Canada’s largest banks are somewhere between these two outliers.

Another perk this ETF has is that it pays out distributions on a monthly basis. The yield, based on trailing dividend payments, is approximately 3.7%.

While I’ll admit this ETF does have a few pluses, I still think it’s a silly product for an individual investor to own. You can easily create it on your own and avoid the management fee.

Let’s say you have $10,000 to invest in Canada’s bank stocks and pick this ETF. You’ll be charged 0.55% per year in management fees (0.62% including HST), which works out to $62 per year.

Meanwhile, you can use a leading online brokerage — which charges $5 per trade plus HST — and build a permanent position in these six stocks for about half the price. It’s an investment that pays for itself in just six months.

These fees can really add up over a decade or two. The ETF will be charging 0.62% of assets annually for years, while your homemade position will only require you to pay twice — once when you buy the stocks and again when you sell. There’s no fee for holding individual stocks.

You’ll also collect higher dividends by buying individual bank stocks yourself. A portfolio consisting of equal positions in Canada’s six largest banks without management fees would yield 4.36% today. That’s much higher than ZEB’s yield, as a certain percentage of dividends gets siphoned off to pay management fees.

The bottom line

Resist the urge to buy this ETF. Sure, it might seem like an easy, no-fuss way to get exposure to Canada’s largest banks, but you’ll pay for the privilege.

A better solution is to just buy shares yourself. Even if you rebalance periodically, it’ll still end up cheaper than owning this ETF over the long-term. And in the meantime, you’ll enjoy much higher dividend yields, something that will ultimately lead to better returns.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nelson Smith owns shares of BANK OF NOVA SCOTIA. The Motley Fool recommends BANK OF NOVA SCOTIA.

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