VFV Is Great: Here’s Why You Shouldn’t Buy it

This low-cost S&P 500 ETF is a great pick, but you shouldn’t blindly buy it. Here’s why.

| More on:
You Should Know This

Image source: Getty Images

S&P 500 ETFs like Vanguard S&P 500 Index ETF (TSX:VFV) have long provided Canadians with a hassle-free and affordable way to invest in the U.S. stock market.

However, as stellar as VFV is, it isn’t suitable for every investor in every situation. The construction of VFV comes with nuances that could potentially lead to confusion or, in a worst-case scenario, panic selling if you’re not fully aware of what you’re getting into.

Let’s look at two specific reasons why VFV might not be the best fit for your investment strategy. We’ll go over two alternative ETFs that could be better picks depending on the scenario.

It’s not currency-hedged

VFV operates by taking your Canadian dollars, converting them into U.S. dollars, and then using those funds to buy shares of a U.S.-listed S&P 500 ETF that holds U.S. stocks.

This process exposes you to the fluctuations in the CAD-USD exchange rate because VFV is not currency hedged. This means that changes in the exchange rate can significantly impact your investment returns, for better or worse.

When the U.S. dollar strengthens against the Canadian dollar, as it has recently, VFV can be expected to outperform the S&P 500 when measured in Canadian dollars.

Conversely, if the Canadian dollar strengthens against the U.S. dollar, as it has at times in the past, your investment in VFV could underperform compared to the S&P 500.

If you prefer to avoid this additional layer of volatility caused by currency fluctuations, you might consider a currency-hedged version of this ETF. One such option is Vanguard S&P 500 Index ETF (CAD-hedged) (TSX:VSP).

It’s subject to foreign withholding tax

As a Canadian-listed ETF that holds U.S. assets, VFV is subject to a 15% foreign withholding tax on the dividends it distributes.

This deduction can significantly impact your overall returns, particularly when compared to what you might have earned had all dividends been fully reinvested without the tax impact.

This withholding tax is unavoidable for Canadian investors holding U.S. assets in non-registered accounts or TFSAs. However, there is a way to bypass this tax if you are investing through a Registered Retirement Savings Plan (RRSP).

By investing in a U.S.-listed ETF, such as Vanguard S&P 500 ETF (NYSEMKT:VOO) within a Registered Retirement Savings Plan (RRSP), you can avoid the foreign withholding tax due to the tax treaty between Canada and the U.S., which recognizes RRSPs.

However, it’s important to consider the currency conversion factor. Investing in a U.S.-listed ETF requires converting Canadian dollars to U.S. dollars, which can come with its own costs unless you have a cost-effective method of currency conversion.

If such conversions prove too costly or complex, sticking with VFV might still be the better option despite the 15% withholding tax on dividends, as it simplifies the investment process and eliminates currency exchange concerns.

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 Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

More on Investing

sale discount best price
Energy Stocks

Time to Pounce: 1 Phenomenal TSX Stock That Hasn’t Been This Cheap in a While

Now could be the time to get into Cameco (TSX:CCO) stock, which is up 81% in the last year but…

Read more »

Digital background depicting innovative technologies in (AI) artificial systems, neural interfaces and internet machine learning technologies
Tech Stocks

3 Millionaire-Maker Tech Stocks That Should Be on Your Radar

These three tech stocks have already proven themselves worthy, but have a lot more to prove in the near future.…

Read more »

A close up image of Canadian $20 Dollar bills
Tech Stocks

3 No-Brainer Stocks to Buy With $20 Right Now

These three stocks are easy buys for those who don't have all that much to spend, and want long-term growth…

Read more »

calculate and analyze stock
Dividend Stocks

4 Fabulous Dividend Stocks to Buy in July

Are you looking for long-term income? These four dividend stocks should not only provide you with value in July but…

Read more »

Hand arranging wood block stacking as step stair with arrow up.
Stocks for Beginners

The Top 3 Long-Term TSX Growth Stocks to Buy Today

These three growth stocks might be some of the best-performing stocks of the last year, but according to analysts so…

Read more »

financial freedom sign
Dividend Stocks

5 Steps to Financial Freedom for Canadian Millennials

Follow these steps and nothing can stop Canadian millennials from achieving their early retirement dreams.

Read more »

top TSX stocks to buy

3 Top Canadian Growth Stocks That Could Make You Rich in 10 Years

Given their healthy growth prospects and attractive valuation, these three growth stocks could create superior wealth in the next 10…

Read more »

edit Sale sign, value, discount

Couche-Tard Stock is a Tremendous Bargain Today

Alimentation Couche-Tard (TSX:ATD) stock looks like a great bargain ahead of its coming earnings report.

Read more »