Are you looking for exchange-traded funds (ETFs) to hold in your Tax-Free Savings Account (TFSA)?
If so, you might be making a wise choice. Studies repeatedly show that diversified broad market index funds outperform the average actively managed portfolio based on similar stocks. Not only that, but index funds achieve their respectable results without the high fees associated with actively managed funds.
With that said, not all ETFs are created equal. Many unscrupulous investment vendors have noticed the rise in passive investing and responded by marketing high-fee ETFs with poor security selection, more similar to overpriced hedge funds than the passive ETFs that gave ETF investing its stellar reputation. In this article, I will explore two TSX index funds that will really give you the benefit of diversification at a low cost.
TSX 60
iShares S&P/TSX 60 Index Fund (TSX: XIU) is Canada’s most popular domestic-market-oriented index fund. It’s based on the TSX 60, the 60 biggest Canadian companies by market cap. It is heavily invested in industries like banking, energy, and utilities, meaning that it should enjoy good relative performance if the current crop of U.S. tech giants is overpriced, as many top investors think they are.
XIU is a true passive ETF. It simply invests in the TSX 60 stocks in proportion to their market cap weighting. This means that the fund has an ample amount of diversification. Perhaps even more importantly, it means that nobody is being paid to pick and analyze stocks for the fund, which contributes to its low 0.16% annual fee.
The fact that XIU is so liquid and frequently traded can be seen as an advantage in itself. When a security is very popular, it tends to have low bid-ask spreads, which reduce the fees you pay to market makers. Also, XIU has about a 2.84% dividend yield, which is high for a broad-market index fund. This fund will add a bit of passive income to your portfolio.
Canadian dividend stocks
BMO Canadian Dividend ETF (TSX: ZDV) is a Canadian ETF offered by Bank of Montreal (TSX: BMO). As you might imagine, it holds a lot of banks, energy companies and utilities. Its holdings are actually quite similar to those of XIU, except with the non-dividend stocks filtered out. So, for example, ZDV gives you no exposure to Shopify.
ZDV is not exactly a pure “index” fund, as it tracks no specific index. However, its methodology is fairly simple (a few basic dividend characteristics have to be met for a company to be included in the fund). This “nuts and bolts” portfolio construction approach is not too far from indexing; you could think of it as sort of like BMO having made a “TSX dividend index” of its own in-house and built the fund on that. At any rate, the fund’s fairly simple methodology results in it having a modest 0.39% management expense ratio. That’s not too far from “true” index funds, so ZDV merits a look from cost-conscious investors.
Foolish takeaway
People often think that investing is all about coming up with brilliant stock ideas. That’s not really it at all. By holding a diversified portfolio, you can enjoy adequate returns with minimal risk. The two ETFs mentioned in this article would be great ones to get started with.
