Great low-cost ETFs for the U.S. stock market
Canada is a great country – arguably I think we have it the best in the world here!
Unfortunately for Canadian investors though, our Canadian stock market is poorly diversified. It’s dominated by financials and energy companies. This means you should consider ETFs to capture the U.S. market.
In fact, as our big-5 or big-6 banks go (you know the names) and as various energy companies go (like Suncor, TransCanada, Enbridge, Pembina Pipeline among others), so can go our Canadian economy.
As of early this year – here are the top-10 holdings in our Canadian stock market, by proxy, using low-cost Canadian ETF leader XIC although that could change of course:
Image courtesy of iShares Canada.
While companies in this top-10 list are historically cash cows (who knows what the future holds?), owning just 10 or 20 Canadian stocks does not make an entire portfolio for most investors.
This is why we should consider investing beyond Canada’s borders. I do.
Overcoming my Canadian bias
For almost a decade now, I’ve been building a dividend income machine that focuses on buying and holding a basket of Canadian dividend paying stocks inside my TFSA and non-registered account.
You can see the results visually here:
While the journey has been good, so far, I do recognize I need to move past my love for Canadian stocks and branch out to invest in the rest of the world more going-forward. I’m working harder on that with every passing year.
Well, not only will my portfolio be able to withstand any major Canadian stock shocks, I’ll also take advantage of growth and income from the around the world.
Keeping my ETF assets in the right location
Pretty much exclusively, I hold my U.S. assets in my Registered Retirement Savings Plan (RRSP). I hold a few U.S. stocks and U.S. ETFs in my RRSP.
Because under our existing Canada-U.S. tax treaty, dividends from individual U.S. stocks or U.S.-listed Exchange Traded Funds (ETFs) are exempt from U.S. withholding tax (15% withholding tax) if the stock shares or ETF units are held in an RRSP or other registered retirement account, like a Locked-In Retirement Account (LIRA) or a Registered Retirement Income Fund (RRIF).
Back to the tax treaty, at this time, this treaty does not recognize our Tax Free Savings Accounts (TFSAs) as a retirement account (even though I definitely do)!
So, the 15% withholding tax for U.S. stocks or U.S.-listed ETFs held within a TFSA will apply.
Part 1 – Own low-cost U.S.-listed ETFs
All data and information is current at the time of this post:
|Vanguard Total Stock Market ETF (VTI)||“Set and forget” the U.S. portion of your portfolio with just one fund||0.04%||3,639||1.9%||7.91%|
|Vanguard S&P 500 ETF (VOO)||S&P 500 focused; own the biggest 500 U.S. stocks and don’t look back||0.04%||511||1.9%||8.45%|
|iShares Core S&P 500 ETF|
|SPDR S&P 500 ETF (SPY)||0.09%||505||2%||9.18%|
|Schwab U.S. Large-Cap Growth ETF (SCHG)||Focuses on large-cap stocks; tech heavy (35%-40%); consumer stock heavy (20%)||0.04%||414||~2%||16.0%|
|SPDR Portfolio Total Stock Market ETF (SPTM)||Less stocks than super-ETF VTI but same low killer-fee||0.04%||2,645||1.8%||7.91%|
|Vanguard Dividend Appreciation ETF (VIG)||Bias to dividend growers; companies that grow dividends year after year||0.08%||182||2%||7.6%|
|iShares Core Dividend Growth ETF (DGRO)||Blend of income and growth; acts more like an S&P 500 fund; with a balance of financials, healthcare, tech., industrials||0.08%||480||2.3%||n/a|
|Other Income-Oriented Funds|
|Vanguard High Dividend Yield ETF (VYM)||Get modest income with growth; top-10 consume >25% of assets||0.08%||400||2.8%||7.8%|
|iShares Core High Dividend ETF (HDV)||Income-oriented but less diversity than competitors above||0.08%||75||3.4%||7.42%|
No doubt there are more low-cost U.S. ETFs to consider. I do believe anything in this list long-term (meaning 10, 15 or 20-years) should suit you very well.
Part 2 – Own low-cost Canadian-listed ETFs (that hold U.S. stocks or U.S. ETFs)
Canadian-listed ETFs (that hold U.S. stocks) have big benefits but also some drawbacks over owning their U.S. ETF friends.
Here are three important considerations that come to mind.
- Currency conversions. Depending upon the discount brokerage you use, there could be a mark-up in converting Canadian dollars to U.S. dollars. By buying Canadian-listed ETFs that hold U.S. stocks or U.S. ETFs you avoid currency conversion headaches or work to “gambit” your money to U.S. dollars.
An example: You can consider buying the Canadian fund VFV instead of buying U.S. fund VOO. More details about VFV below.
- U.S. estate taxes. This is a complex subject worth a few posts unto themselves but essentially if you’re wealthy enough to hold millions of assets (i.e., about $11 million based on 2018 guidance) AND you hold some U.S. assets as part of your worldwide net worth, you might be subject to U.S. estate taxes at time of death. My understanding is, based on recent U.S. law changes:
- If the value of your U.S. situs assets (e.g., stocks, bonds, ETFs, U.S. real estate, etc.) on death is > $60,000 USD, your estate representative must file a U.S. estate tax return regardless of whether there is an estate tax liability. Ouch.
- If the value of your U.S. situs assets is $60,000 USD (or less) at time of death, my understanding is you will not be subject to U.S. estate tax regardless of the size of your worldwide estate and there is no estate tax return filing required.
What isn’t considered “U.S. situs assets”, my understanding is:
- Shares of Canadian mutual fund corporations that invest in the U.S. market (even if denominated in U.S. currency).
- Units of Canadian mutual funds, ETFs trading on the TSX or another exchange that invest in the U.S. market.
- American Depository Receipts (ADRs) – these are exempt from U.S. estate tax because the underlying share holdings are not U.S. corporations.
- U.S. real estate.
- And more and more…
Again, it’s complex and I’m not U.S. tax pro so I’m going to leave it there. If you Google U.S. estate taxes you’ll find tons of articles on this subject and potentially the details you are looking for. I found one very good one by RBC here related the information above. Again, not tax advice just what I understand!
All this to say, if you have millions, you probably have more tax implications than just holding some U.S. ETFs across your portfolio.
- Withholding tax considerations with Canadian-ETFs.
Yes, the withholding tax paradigm is tricky unfortunately.
Essentially, there are no withholding taxes for U.S-listed ETFs inside an RRSP but when you hold Canadian-listed ETFs that hold U.S. assets, withholding taxes apply in an RRSP and TFSA and those are not recoverable.
Exactly how much withholding tax are we talking about?
You know about the 15% of the dividend withheld – so using Vanguard S&P 500 Index ETF (VFV) vs. VOO above as my example, say the S&P 500 via VOO yields closer to 2%.
VFV withholding taxes = 2 (% yield) x 0.15% withholding taxes = 0.30% extra costs to own VFV over VOO in addition to any MER difference.
It should be noted in taxable accounts, VOO and VFV are all treated equally. Investors lose the 15% for withholding taxes still but they can claim a credit for this amount when filing their income tax returns. That sounds like another headache as well.
In the end, buying Canadian-listed ETFs that hold U.S. assets is arguably a very small incremental cost to pay to avoid currency conversions, any potential U.S. estate tax headaches and more – but it needs to be mentioned here as part of your total portfolio cost.
What are some of the best low-cost ETFs for the U.S. market using Canadian ETFs?
All data and information is current at the time of this post:
|iShares Core S&P US Total Market Index ETF (XUU)||A fund of iShares U.S. funds; holds ~60% IVV I mentioned above||0.07%||4||1.7%||n/a|
|iShares Core S&P 500 Index ETF (XUS)*||*Also available in a hedged product (XSP) although that could lower long-term returns based on errors with currency hedging||0.10%||1 (IVV)||2%||13.63%|
|Vanguard S&P 500 Index ETF (VFV)||Tracks S&P 500 as a Canadian ETF that holds VOO U.S. ETF||0.08%||1 (VOO)||2%||13.53%|
|BMO S&P 500 Index ETF (ZSP)||Holds U.S. stocks; investors may consider ZSP.U that holds ZSP units in USD $||0.09%||506||1.6%||13.58%|
|Vanguard U.S. Total Market Index ETF (VUN)||Basically Canadian equivalent of VTI U.S. ETF||0.16%||1 (VTI)||1.5%||12.91%|
No doubt there are more low-cost Canadian ETFs to consider but certainly anything in this list long-term (meaning 10, 15 or 20-years) should suit you very well.
*You might recall the main problem for investors in buying the S&P 500 with any Canadians dollars is that you’re buying companies that trade in U.S. dollars. If the American-$$ weakens relative to the Canadian dollar your investment will be worth less. Conversely, if the American-$$ strengthens relative to the Canadian dollar your investment is worth more loonies and toonies.
Essentially, there are two options available for Canadian investors with hedging: 1) be exposed to currency fluctuations (i.e., stay unhedged); or 2) be currency hedged.
The objective of currency hedging is to reduce the effects of foreign exchange movements over the life of an investment. Personally, if you’re a long-term investor (I mean over decades), I would argue you want to stay “unhedged” and be exposed to changes in currency values.
Summary on ETFs to capture the U.S. market
There are many, many important things to consider when investing in the U.S. market.
I believe making such decisions ultimately it comes down to how much you are willing to invest; where you are going to hold those investments (i.e., in what account), are you willing to absorb the currency rate fluctuations over time, and grasping an understanding of withholding taxes for any investment you purchase.
Once you have made these decisions – those decisions will help guide you into potential ETFs to own.
Regardless of U.S. ETFs or Canadian ETFs that hold U.S. assets – keep your investing costs low and avoid trading. You’ll keep more of your money this way.
Happy investing and I look forward to your comments on this comprehensive post.
Do you own any U.S. ETFs? If so, why? Do you own any Canadian ETFs that own U.S. stocks or hold U.S. ETFs themselves? If so, why? Share your thoughts below.