The SPDR S&P 500 ETF (NYSEMKT:SPY) is one of the most popular investment funds in the world. With a US$384 billion market cap, it’s bigger than some of the world’s biggest companies. The SPY has become such a popular investment that many people invest their entire portfolios in it. It makes sense on some level – because the fund holds 504 stocks –it’s plenty diversified. However, SPY‘s country-specific diversification does not provide the ‘widest’ coverage. Although the fund has many stocks, they’re all U.S. stocks, which means that they are all pretty strongly correlated with one another. So, the diversification benefit is not as great as it appears. To really maximize your portfolio’s diversification, you’ll want some international stocks – including Canadian stocks – in the mix as well. In this article, I will explore how you can achieve that.
Why going all in on SPY is a bad idea
Although the SPY ETF has performed very well recently, it may not perform as well going forward. The outperformance of U.S. stocks has been strong historically, but it has not held in all periods. In the 1970s, for example, Asian equities outperformed their U.S. counterparts for the better part of an entire decade. It was not until the early 1980s that U.S. stocks crawled out of the long slump they had been in. So, it is not a foregone conclusion that U.S. stocks will always outperform global stocks. It’s a good idea to have some global stocks, as well as Canadian stocks, in your portfolio.
How to diversify your portfolio
If you wish to diversify your portfolio away from SPY and the U.S. stocks that it invests in, you can consider Canadian stocks as your starting point. Ideally, you’d have all regions represented, but Canadian stocks are a logical place to start because:
A) If you’re reading this, you’re probably Canadian, meaning that you are likely knowledgeable about several Canadian companies.
B) Canadian dividend stocks are usually taxed less than foreign dividend stocks, because foreign countries usually charge withholding taxes on Canadian shareholders.
When building out your Canadian stock portfolio, you’re well advised to start with low cost index funds. Such funds are extremely diversified, which reduces your risk, and they also charge low fees.
Consider the iShares S&P/TSX 60 Index Fund (TSX:XIU), for example. It’s a Canadian index fund based on the TSX 60 Index. The TSX 60 Index consists of the 60 largest publicly traded Canadian companies by market cap. It includes many banks, oil companies, and utilities. Today, that’s probably a virtue, as tech stocks (of the sort that dominate the U.S. markets) have been flying high most of this year while the underlying businesses have not grown. That situation is probably due for a correction.
XIU gives you exposure to many out-of-favour sectors, and being Canadian, it’s taxed at comparatively low rates. Also, it has a 0.16 management fee, which is fairly low (though not as low as the iShares TSX Composite Fund, its sister fund). Despite the higher fee, XIU has performed better than its sister fund, probably because large cap stocks have been outperforming in recent years. Overall, XIU is a worthy fund to hold in your RRSP or TFSA.
