REDUCING THE RISK
Got stock-phobia? Mix and match ETFs
A good bet: blue chips that pay dividends
When financial markets are in turmoil and the economy is on the ropes, the thought of buying individual stocks strikes terror into the hearts of many investors, especially those planning for retirement. What if the company gets into trouble and has to chop its dividend, or worse, files for bankruptcy protection or even liquidation? Nortel or Circuit City, anyone?
But plowing your entire RRSP into low-yielding GICs isn't the solution either, because over long periods stocks have been the clear winner over fixed-income investments. What's more, the best time to buy equities is when they've tumbled in price, not when they're hitting record highs.
So how can an investor get exposure to the stock market without the risk of putting a big chunk of cash into a company that's about to blow up?
That's where exchange traded funds come in.
ETFs are like mutual funds, only better. They provide diversification by investing in a basket of companies, which minimizes the impact that any one stock will have on your portfolio. But their fees are substantially lower than mutual funds, which means they deliver superior long-term returns.
And because ETFs trade like stocks, you can buy and sell them during the day, rather than having to wait for the mutual fund company to process your order after the market closes - at a price you can't control.
The number of ETFs has exploded in recent years, making the task of selecting an appropriate one overwhelming for many investors.
But for my money, the best ETFs are the ones that keep it simple by investing in blue-chip companies with a long track record of paying dividends.
Why are dividends important? Because studies have shown that dividend-paying stocks outperform non-dividend stocks over the long haul.
The best stocks of all are those that not only pay dividends, but also raise them regularly.
One example of an ETF that focuses on dividend-growing companies is the iShares CDN Dividend Index Fund.
It includes all the big Canadian banks, insurers, pipelines and utilities, plus a few lesser-known dividend stars such as Reitmans and Russel Metals. The management expense ratio is just 0.5 per cent, compared with 1.5 per cent or more for most dividend mutual funds.
One drawback of this ETF is its heavy concentration - about 60 per cent - in financials. But if you believe banks, insurers and mutual fund companies will rebound when the economy recovers, then buying this ETF now, after it has tumbled more than a third from its peak, may turn out to be a smart move. You'll collect a rich yield of 5.9 per cent now, and you'll be rewarded by rising dividends and a higher share price later, assuming the economy gets back on its feet.
A second fund worth considering is the Claymore CDN Dividend & Income Achievers ETF, which has a slightly higher management expense ratio of 0.6 per cent and invests in common stocks as well as income trusts and real estate investment trusts. A couple of points to keep in mind: The proportion of financials is still quite high, at 50 per cent, and the ETF's distributions could be affected when income trusts start being taxed in 2011.
If having such heavy exposure to financials scares you, there are other options. For example, you could look to a U.S. fund such as the Vanguard Dividend Appreciation ETF, which has less than 10 per cent of its assets in financials and more than one-third in less-volatile consumer stocks such as Johnson & Johnson, Coca-Cola, Procter & Gamble and McDonald's.
Perhaps the best strategy is to mix and match ETFs, thereby spreading your risk across even more stocks and sectors. By diversifying with dividend ETFs, you won't lose sleep worrying that one of your stocks will plunge. And while you wait for markets to recover, you can spend your time counting up the cash that lands in your RRSP account.