Index funds
Some advice that’s frequently repeated on financial sites is to invest in index funds instead of actively managed mutual funds. Even professional fund managers fail to outperform the market frequently, and picking one of the top 10% can be harder than it sounds. By buying in to an index fund you can follow the market in general, which tends to go up over time. The S&P 500 index is usually cited as the best choice, and the number of funds based on it is growing.
That’s all nice and well, but what does it mean here in Canada? There’s 3 options available to everyone:
- Buy US index funds as ETFs
- Invest in a Canadian dollar S&P 500 index fund
- Invest in a Canadian index fund
First, you can sign up for an online brokerage and find several S&P 500 funds listed as exchange traded funds such as the SPDR 500 fund (ETF: SPY) or iShares S&P 500 (ETF: IVV). This option allows you to get into some of the most popular funds for this investment, but the downside is that you have to pay commissions for every trade. Ideally you can make larger investments 2-3 times per year. This isn’t a strong point when compared to actual mutual funds where you can invest $25-50 at a time with no costs, and add money monthly or even weekly. The upside is that US ETFs can have expense ratios below 0.2%, compared to Canadian funds which rarely go below 1.0%.
Side note: some S&P 500 index funds in the US use different weightings. Most funds invest assets in each stock based on its market value weighting in the S&P index (eg, 3.7% held in Exxon stock). While this helps them closely approximate the market’s performance, that’s not a good thing when the market drops. Some funds, like the Rydex Equal Weight fund (ETF: RSP), keep the same list of stocks but invest equal amounts in each one or weight them according to cashflow. This gives them different returns and may outperform the actual S&P 500 index. It’s an interesting idea, but so far it only seems to be done for S&P 500 funds.
Secondly, you can find some Canadian dealers that have funds based on the S&P 500. While this gives you access to the same investment vehicle in principle, these funds are less well known and may choose to structure their portfolio in a different way (even with the same list of stocks, funds can allocate the money in a variety of ways).
One downside of both these approaches is that you’re ultimately buying something in US dollars. Although it may be a solid investment for americans, it adds exchange rate risk to your investment. If rates go back to their prevous level, the current rates near 1:1 may be an excellent chance to buy in to this and have a double gain; on the other hand, the US dollar may fall even further, causing the index to lose value.
An alternative is index funds based on the S&P/TSX composite index. Unlike the S&P 500 it’s all Canadian, and unlike actively managed Canadian funds you can get lower expense ratios and quite possibly better returns. With these funds you can enjoy index fund investing without worrying that the currency it’s based on will go south. They also let you invest as a regular mutual fund customer, with no commissions and smaller deposits, instead of buying an ETF.
Ultimately, S&P 500 index funds are widely regarded as a reliable investment that performs reasonably well, but any way you invest in them you have to deal with currency exchanges. S&P/TSX index funds apply the same idea to the Canadian markets, making them an easier investment.