Today, I’m going to travel beyond our borders, venturing south into the heart of one of the world’s most powerful economic engines: the U.S. stock market. More specifically, I’ll be shining the spotlight on the S&P 500, a broad-market index that has, time and again, proven itself as a reliable growth engine.
You may have heard the arguments for individual U.S. stock picks or the allure of actively managed funds promising high returns. However, the simplicity, diversity, and proven long-term performance of the S&P 500 make it a compelling case for Canadians looking to expand their investment horizons.
To put it bluntly, I think both of those strategies will lose to an S&P 500 index fund over the long term. Here are some arguments and evidence as to why I believe that, along with an exchange-traded fund (ETF) pick to potentially put it into practice if you agree with me.
SPIVA doesn’t lie
Let’s begin with a critical examination of actively managed funds, a commonly proposed alternative to index investing. The allure of such funds lies in the prospect of achieving higher-than-average market returns, thanks to the supposedly superior market insights of fund managers.
However, a review of the latest SPIVA (S&P Indices Versus Active) scorecard from S&P Dow Jones Indices paints a different picture. The SPIVA scorecard provides a semi-annual comparison of actively managed funds against their respective benchmark indices. It offers an evaluation of the active-versus-passive-investing debate, shedding light on the real, long-term performance of actively managed funds.
According to the most recent SPIVA scorecard, over the last 15 years, a staggering 93.40% of U.S. large-cap funds underperformed the S&P 500. This data implies that only a tiny fraction of actively managed funds succeeded in outperforming the market, despite higher costs and often-lauded expertise.
This outcome may be surprising for some, but it echoes the thoughts of renowned investor Warren Buffett, who famously wagered a bet that an S&P 500 index fund would outperform a selection of hedge funds over a ten-year period — a bet that he won.
It’s hard to beat the S&P 500
This evidence underscores one of the key reasons the S&P 500 is considered an ultimate growth engine. By investing in a fund that tracks this index, you’re essentially buying a slice of the top 500 companies in the U.S., thereby gaining broad exposure to the market’s growth.
And as the SPIVA scorecard suggests, this simple strategy has proven more effective than the majority of actively managed U.S. large-cap funds over the past 15 years. If professional fund managers find it hard to beat the S&P 500, what hope do amateur stock pickers have?
The allure of individual stock picking is undeniable. The idea of investing in the next big thing and watching your initial investment multiply many times over is thrilling. However, the harsh reality is that picking individual stocks successfully and consistently is extremely challenging.
For one, it involves a considerable amount of time, effort, and knowledge. You need to deeply understand each company’s financials, industry position, competitive landscape, and future prospects. Furthermore, you must continually monitor market news, quarterly reports, and various other factors.
Even more compelling, a 2018 study published in the Journal of Financial Economics found that most of the overall gains from the U.S. market over the past 100 years can be attributed to just 4% of listed stocks. The likelihood of consistently choosing the winning minority of stocks ahead of time is incredibly low.
If you can’t beat them, join them
Convinced? Alternatively, an investment in a S&P 500 ETF allows investors to benefit from the growth of the American economy, without the need to pick individual winners or sectors.
An S&P 500 ETF passively tracks the index, mirroring its composition and performance. This approach means that, as an investor, you’ll own a small piece of each company within the S&P 500 — a level of diversification that’s hard to achieve if you’re picking individual stocks.
Cost is another crucial factor to consider. Since ETFs passively track an index, they require less active management, translating to lower costs for investors. My favourite Canadian-listed S&P 500 ETF is BMO S&P 500 Index ETF (TSX: ZSP), which charges a 0.09% expense ratio.
