One of the first lessons Canadian investors learn about the Tax-Free Savings Account is that “tax free” does not always mean completely tax free. If you hold U.S. stocks or ETFs inside a TFSA, dividends are still subject to a 15% foreign withholding tax from the United States.
That tax is taken off the dividend before the payment even reaches your account, and unfortunately there is no way to recover it in a TFSA. That is one reason many investors choose to keep a portion of their portfolio in Canadian investments when using this account.
Another factor is home country bias. While Canada represents only a small portion of the global stock market, many portfolio managers still recommend keeping somewhere in the range of 10% to 30% allocated to domestic equities.
Major firms like Vanguard and iShares incorporate this approach in many of their model portfolios because it reduces currency risk and can provide more tax-efficient income.
If you want a simple Canadian core inside a TFSA, here are three exchange-traded funds (ETFs) from BMO Global Asset Management that I like. Together, they move from broad market exposure to blue-chip large caps to higher dividend income.
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BMO S&P/TSX Capped Composite Index ETF
The BMO S&P/TSX Capped Composite Index ETF (TSX:ZCN) is one of the simplest ways to invest in the Canadian stock market.
This ETF represents the majority of publicly traded companies on the Toronto Stock Exchange. The portfolio includes over 200 large, mid, and small-cap companies, giving investors exposure to the full breadth of the Canadian equity market.
Because the index is market-cap weighted, the largest companies naturally make up a bigger portion of the portfolio. This means sectors like financials, energy, and materials play an important role in the fund’s performance.
For investors looking for a core Canadian holding, ZCN acts as a broad foundation for a portfolio. It charges an uber-low 0.06% management expense ratio (MER) and pays a 2.2% dividend yield.
BMO S&P/TSX 60 Index ETF
The BMO S&P/TSX 60 Index ETF (TSX:ZIU) narrows the focus to the largest and most established companies in Canada.
This ETF tracks the S&P/TSX 60 Index, which contains the country’s biggest publicly traded corporations. These companies tend to be highly liquid, widely followed by analysts, and dominant within their industries.
The portfolio is heavily weighted toward familiar Canadian names in sectors such as banking, energy, telecommunications, and pipelines. These businesses form the backbone of the Canadian economy and are often considered blue-chip investments.
Compared to a broader index fund, ZIU provides a more concentrated portfolio of Canada’s largest and most stable companies. It charges a higher 0.18% MER, but pays a greater 2.3% dividend yield.
BMO Canadian Dividend ETF
For investors who want a stronger income component, the BMO Canadian Dividend ETF (TSX:ZDV) may be ideal.
The fund screens for companies based on a three-year dividend growth rate, yield, and payout ratio. Financial institutions, pipelines, and telecommunications companies make up a large portion of its 60-plus holdings.
This type of ETF can be particularly well-suited for a TFSA because Canadian dividends can grow and compound inside the account without any tax drag. ZDV pays the highest dividend yield at 3%, but is also the most expensive with a 0.39% MER.
