Index investing using Exchange Traded Funds (ETFs) has become very popular in recent years, and rightly so. There are huge advantages to index investing:
- Low money management fees
- Market-like returns
- Long-term growth potential
These are great things when it comes to investing.
I believe a case can be made however to unbundle your Canadian ETF over time for income. One of the main reasons to do this: our Canadian economy operates as an oligopoly – a few players that have huge market shares within a few industries. There are only so many blue-chip stocks that fuel our Canadian economy (although a number of smaller-cap stocks will always support some growth). The other reason is: by owning Canadian blue-chip companies directly you can receive a healthy dose of dividends for passive income. Capital gains are also a nice long-term bonus.
“The crux of your success will be selecting leading companies’ stocks and then holding on to them for many years. While you cannot go to sleep, and there is a place for monitoring, there is no reason to panic if a firm has earnings that fall short in a given year or two. This is quite a normal phenomenon.” – Stephen Jarislowsky, The Investment Zoo; author, billionaire businessman, philanthropist.
Think about our banking industry for a moment. I bet you can count the number of major players in this sector on two hands. Banking with Tangerine or PC Bank? Good for you and smart stuff. Most of their accounts don’t charge any banking fees. (Don’t forget those companies are owned by ScotiaBank (BNS) and CIBC (CM) that pay healthy dividends respectively.)
What about life insurance companies and other financials? No doubt most of you have heard of Sun Life (SLF), Manulife (MFC) and Great-West Life (GWO). Financials including life insurance companies consistently make up between 30-35% of our Canadian market. Failure to own any Canadian financial stocks will likely damper your long-term Canadian equity returns – although you shouldn’t put too many eggs into this basket.
The energy sector makes up about 20% (or more) of our Canadian market at any given time. Companies like Suncor (SU), Canadian Natural Resources (CNQ), Cenovus (CVE) and Crescent Point Energy (CPG) are household names. They also pay dividends.
What about materials? Heard of Barrick and Goldcorp, or Potash and Agrium? This sector makes up close to 15% of our Canadian market. You might want to consider owning a few material stocks although the ride can be bumpy at times due to their cyclical nature.
Within the game of Monopoly, industrial companies like railroads are usually a good core holding for gaming success. Companies like Canadian National Railway (CNR), Canadian Pacific Railway (CP) and construction companies like SNC-Lavalin (SNC) can help diversify your portfolio. This sector makes up about 9% of the Canadian market.
Our consumer discretionary sector (think grocery stores and companies like Canadian Tire (and more)) make up about 6% of our Canadian market.
Consider owning the companies you love to hate. I’m writing about our Canadian telecommunications industry – I’m sure “the big three” come to mind within the moniker “Robellus” – Rogers (RCI.B), Bell (BCE) and Telus (T). Think of these fine companies every time you pay your internet bill or cell phone bill. This industry makes up about 5% of our Canadian market.
What about utilities? Fortis (FTS), Emera (EMA), Canadian Utilities (CU), and Hydro One (H) dominate this sector.
There are other, equally small sectors like healthcare that make up our Canadian economy but I think you get the idea by now – there are a few huge companies who earn very big profits. These companies are household names.
By unbundling your Canadian ETF such as XIU, XIC, VCN or another popular Canadian equity ETF, into a mixture of stocks held across the many sectors I mentioned above, you can save the money management fees every year and build an income portfolio for retirement income needs.
Want to own more utilities? Thinking just 3% of this sector held in the ETF XIC isn’t enough? You can. Think 5% of your Canadian portfolio is too low for the profits churned out by the biggest telcos in Canada year after year? I feel this way, maybe you do too.
“I also do not believe in buying companies that do not pay attractive dividends. Nobody can forecast the future. But it’s obvious that companies that have a strong uninterrupted record are more interesting than those that have not.” – Stephen Jarislowsky, The Investment Zoo.
I haven’t even mentioned Canadian Real Estate Investment Trusts (REITs) yet. Instead of paying money management fees close to 0.60% to own the REIT ETF XRE or even 0.39% to own Vanguard’s REIT ETF VRE, I’ve decided to unbundle this product. I’ve since built my own REIT ETF – owning companies like RioCan, Allied Properties and many other companies directly.
Critics of this article will highlight a few things. Indexing is simplistic and easy. Owning individual stocks is not and it can introduce a number of behavioural investing biases that are difficult to overcome. True enough. Critics will also say there are too many risks involved in owning a few dozen Canadian companies (like the ones above) instead of owning the 240+ companies that make up Canadian market. There is more risk. However no investment approach comes without risks. Holding cash too long has risks. Holding GICs has risks. Dollar cost averaging has risks. Indexing has risks. With indexing, one risk is, with all the glory that comes with diversification you’ll own the “the studs and the duds” – companies that do well and companies that will suffer – and you’ll pay a money management fee for those companies regardless.
Don’t get me wrong – index investing is a solid approach for long-term investing success. Academic studies prove that. But it’s not the only way to invest. Ultimately investors will want income from their portfolios someday. This makes buying and holding Canadian companies that distribute fairly predictable cash flow to shareholders a viable way to get it.
Investors seeking steady income, with some capital appreciation, can consider unbundling their Canadian ETF at some point. You could consider this approach for our Canadian market only. Then you can index invest the rest of your portfolio for international exposure – using a few ETFs I’ve listed here.
What’s your take on our Canadian market dominated by a few sectors? Thoughts on a handful of companies that dominate their sector?