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Over the last two decades, the Canadian stock market has delivered returns that outpace inflation for its shareholders. However, it has significantly lagged behind the broader U.S. indices. Since July 2004, the TSX index has provided a dividend-adjusted gain of 400%. In contrast, major U.S. indices like the S&P 500 and the Nasdaq Composite have achieved returns of 641% and 1,007%, respectively.
Diversification and Risk Reduction
A natural tendency exists for investors to favor domestic companies and brands due to familiarity. Yet, it’s crucial for Canadians to recognize that their stock market represents a mere 3% of the global market by weight. In contrast, the U.S. economy, being the largest globally, offers exposure to some of the most dynamic and innovative companies.
Many Canadians heavily invest in the TSX index, which may not be the wisest strategy. While Canadian stocks provide tax benefits through registered accounts like the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP), dividends from U.S. stocks held in a TFSA incur a 15% tax. Despite these tax considerations, the risk of not diversifying into U.S. stocks is substantial. U.S. investments not only provide the potential for double-digit annual gains but also enhance portfolio diversification, reducing overall investment risk.
Higher Exposure to the Tech Sector
Canada’s largest companies are predominantly in the banking and energy sectors. Notable Canadian stocks include Royal Bank of Canada (TSX:RY), Canadian National Railway (TSX:CNR), and Enbridge Inc. (TSX:ENB). Conversely, the leading U.S. companies are tech giants such as Apple, Microsoft, Nvidia, Amazon, Meta, and Alphabet. These tech behemoths boast high profit margins, strong competitive advantages, and are positioned in growing markets, making them likely to outperform their Canadian counterparts.
Investing in U.S. Stocks
For Canadians looking to invest in the U.S. stock market, exchange-traded funds (ETFs) like the Vanguard S&P 500 Index ETF (TSX:VSP) are an excellent option. This ETF, with over $3.3 billion in assets, tracks the S&P 500 index and is hedged to the Canadian dollar to mitigate exchange rate fluctuations. Over the past decade, the VSP has delivered a return of 11.46%, closely matching the S&P 500's 11.71%. With a management fee of 0.08% and an expense ratio of 0.09%, the VSP ETF is a cost-effective, passive index fund.
The S&P 500 index, dominated by the tech sector, includes 500 U.S. stocks with a median market cap of $311 billion. The VSP ETF's holdings have a median price-to-earnings ratio of 26.1, an earnings growth rate of 15.7%, and a return on equity of 24.6%. The ETF allocates 30.6% of its weight to information technology, followed by 12.9% to financials and 12% to healthcare.
