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Rob Carrick

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You win either way

Rob Carrick

 

OTTAWA (GlobeinvestorGOLD) — The most effective way to invest in the U.S. stock market will survive the Kerry versus Bush confrontation, just as it has Bush versus Gore, Clinton versus Dole, Clinton versus Bush, Bush versus Dukakis and, well, you get the picture.

There’s simply no easier, cheaper and more durable way to get your required U.S. equity market exposure than through an exchange-traded fund called the iShares S&P 500 Index Fund. As goes the world’s most important economy, so goes the S&P 500 stock index, which this ETF tracks. While some people dwell on the ups and downs of the Dow Jones industrial average, it’s the S&P 500 that’s the real barometer of U.S. stock market performance.

Pundits may have spend a lot of time hashing out whether Kerry or Bush would be better for the stock markets, but this isn’t the sort of thing the has a long-term effect on stock prices. Rather, it’s the profits generated by the likes of the companies in the S&P 500. We’re talking here about such heavyweights as General Electric Co., Microsoft Corp., Exxon-Mobil Corp., Pfizer Inc., Citigroup Inc. and Wal-Mart Stores Inc.

The S&P 500 is a large-capitalization index, which means it includes only big stocks and not the sort of smaller-caps that can sometimes provide outstanding returns. Still, the S&P 500 performs. By investing in this index, you’ll typically find yourself outperforming a majority of U.S. equity funds run by managers who actively select their own stocks. In fact, only five of 36 U.S. equity funds with a 10-year record beat the S&P 500, and two of those funds are available only to high-net-worth investors.

Unfortunately, the near-term returns that Canadians have received from the S&P 500 and other U.S. markets have been hurt by the strong appreciation of the Canadian dollar. While the index was up almost 6 per cent over the past 12 months in U.S.-dollar terms, the gain in Canadian dollars was a little less than 2 per cent. You have to be philosophical about this as an investor. The decline in the Canadian dollar for years boosted the returns from U.S. equity funds, and the current reversal will at some be followed by another change in the currency power balance.

If you’re dead certain the Canadian dollar is heading higher against the U.S. dollar over the long term, try one of those S&P 500 index funds that are considered domestic content for registered accounts thanks to their use of derivatives. These funds, available from bank fund families such as RBC and TD, provide returns that are insulated from currency moves.

Investors who are even slightly familiar with exchange-traded funds might wonder why the iShares S&P 500 fund is suggested as the best way to play this benchmark index. By far the most popular ETF play on the broad U.S. market is the Standard & Poor’s Depositary Receipt, commonly known by the acronym SPDR and the informal moniker Spider (SPY-Amex). Spiders are great — there’s not a thing wrong with them. It’s just that if you’re after the cheapest possible exposure to the S&P 500, the iShares fund wins on the strength of an management expense ratio of 0.09 per cent as opposed to the 0.12 per cent of Spiders. Note: if you want to actively trade your S&P 500 fund, the greater liquidity of Spiders will override the MER disadvantage.

There are a few ancillary benefits of investing in the U.S. market through an ETF. For one thing, you’ll receive a modest dividend now yielding about 1.6 per cent. You’ll also benefit from tax efficiency in non-registered accounts in that your fund will do only a small amount trading (to reflect index additions and deletions) and thus generate minimal taxable capital gains distributions.

The market for ETFs has developed to the point where there are now dozens of choices for gaining exposure to U.S. equities. You can buy medium- and small-cap ETFs, total-market ETFs that include large-, medium- and small-cap stocks and versions of indexes like the S&P 500 that emphasize either growth or value stocks. Some of these ETFs have merit, but none match an S&P 500 ETF for all-around practicality.

Rob Carrick has been writing about personal finance, business and economics for more than 12 years.

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