One of the most difficult investment decisions is picking the “right” stock to invest in. You can buy the best performing bank stock and it suddenly announces it has to write-down a significant asset portfolio due to some economic event you never dreamed of.
This is why I’m a big believer in Exchange Traded Funds (ETF) as you are buying a ready-made portfolio, which provides diversification and reduced volatility.
However, you still need to understand what you’re investing in. It’s very important to understand what investments make up the ETF. In Canada, you have two ETFs that cover the broad stock market. One is the TSX/S&P 60 and the other is the broader Core S&P/TSX Composite Index.
The S&P 60 is made up of the 60 highest capitalized stocks that trade on the TSX. Its one-year return is 12.16% and its return since inception is 6.94%. The broader index includes the same 60 stocks as well as another 188 stocks, which trade on the Toronto Stock Exchange. The TSX 60 has outperformed the broader index every year over the past 10 years.
What’s important to understand is the make-up of the ETF. The top 10 holdings of the TSX 60 make up 51% of the total market cap. The top 20 represents 71% of the market cap. These stocks can be broken down into industry segments. The top five segments are as follows:
Mining and Materials 9.4%
Owning this particular ETF provides an excellent and diversified exposure to the Canadian stock market and economy. While the energy and mining sectors have underperformed, all other sectors are in the black. The worse performing stock in the index has been Valeant Pharmaceuticals, which is down 84% over the past 18 months yet only makes up 0.46% of the total portfolio.
What is missing from this index investment is exposure to large consumer markets, information technology, health care and pharmaceuticals as well as large industrials and food manufacturers. To round out a well-diversified portfolio, the smart investor also purchases a Canadian-dollar hedged S&P 500 ETF to gain exposure to these very important market segments.