Index funds track the performance of the broader market or specific industries and are a convenient alternative to active stock-picking.
These funds trade on the stock exchange like regular stocks but offer exposure to a basket of different underlying holdings.
The top 5 best index funds for Canadian investors are:
1. iShares Core S&P/TSX Capped Composite Index (TSX:XIC)
2. iShares S&P/TSX 6 Index (TSX:XIU)
3. BMO S&P 500 Index CAD (TSX:ZSP)
4. iShares S&P/TSX Capped Energy Index(TSX:XEG)
5. iShares S&P/TSX Canadian Dividend Aristocrats Index (TSX:CDZ)
|Ticker||Company||Description||Net Assets||Fees (MER)||CAGR since inception|
|XIC||BlackRock||Offers exposure to the entire Canadian stock market.||$9 bn||0.06%||6.84%|
|XIU||BlackRock||Offers exposure to the 60 most valuable companies in Canada.||$10.6 bn||0.18%||7.40%|
|ZSP||BMO||Offers exposure to the S&P 500.||$9.3 bn||0.09%||16.11%|
|XEG||BlackRock||Offers exposure to the Canadian oil and gas industry.||$1.79 bn||0.60%||6.01%|
|CDZ||BlackRock||Offers exposure to companies that have consistently raised dividend payouts for several years.||$0.91 bn||0.66%||6.78%|
1. iShares Core S&P/TSX Capped Composite Index Fund (XIC)
There are over 1,500 stocks listed on the Toronto Stock Exchange.
Canada’s economy is relatively well-diversified between financial services, energy, commodities and technology.
The iShares Core S&P/TSX Capped Composite Index Fund (TSX:XIC) tends to capture it all in a single fund.
The fund tracks the S&P/ TSX Composite Index – which is Canada’s headline index that represents the 239 largest companies in the country.
XIC’s largest holdings include Royal Bank of Canada, Enbridge and Toronto Dominion Bank.
XIC tends to be heavily exposed to energy and finance.
At the time of writing, these two sectors contribute about 46.8% of the total portfolio.
In other words, half the Canadian economy is based on banking and energy.
These sectors aren’t high-growth, but they’re excellent for dividend income.
XIC currently offers a 2.22% dividend yield.
If you’re bullish on the Canadian economy given the stability of our banking sector and the demand for energy over the long term, this is an excellent index fund for you.
2. iShares S&P/TSX 60™ Index Fund (XIU)
The iShares S&P/TSX 60™ Index Fund (TSX:XIU) is a more concentrated version of the fund mentioned above.
Instead of holding hundreds of companies, this fund focuses on the 60 most valuable companies on the market.
The performance of these larger companies tends to be better over time.
XIU has delivered 7.40% in compounded annual growth since its inception.
That’s marginally higher than XIC’s 6.84%.
However, the largest holdings in both these funds have significant overlap.
XIU’s largest holdings include Royal Bank of Canada, Toronto Dominion Bank and Enbridge.
51.42% of the portfolio is dedicated to financials and energy.
Meanwhile, the dividend yield is 1.93%.
XIU is also more expensive than its broader peer with a management expense ratio of 0.18%, which could reduce the difference in performance between the two funds.
Nevertheless, XIU is an excellent fund for investors who are optimistic about Canada’s energy exports and domestic lending.
3. BMO S&P 500 Index Fund CAD (ZSP)
As aforementioned, Canada’s economy is overexposed to the financial and energy sectors.
Meanwhile, Canadian investors are overexposed to the domestic stock market.
Our nation accounts for just 3% of global stock market wealth, yet Canadians rarely invest in foreign stocks.
Overcoming this home bias could help you diversify your portfolio and bolster long-term performance.
Betting on America’s largest companies could be an excellent way to do this.
The BMO S&P 500 Index Fund (TSX:ZSP) tracks the performance of the flagship S&P 500 index.
This index attracts capital from across the world and is the most valuable index right now.
Unlike the Canadian economy, the US is heavily exposed to high-growth tech stocks.
27.25% of the fund’s portfolio is focused on Information Technology companies.
The three largest holdings in ZSP are Apple, Amazon and Microsoft.
However, there is also considerable exposure to non-tech blue chip stocks like Berkshire Hathaway and Johnson & Johnson.
In terms of performance, the S&P 500 has far outstripped its Canadian peer.
Since inception, ZSP has delivered 16.11% CAGR.
That’s considerably higher than XIU and XIC mentioned above.
The US economy is also expected to continue growing at a steady pace for the foreseeable future.
ZSP currently offers a dividend yield of 1.34% dividend yield.
4. iShares S&P/TSX Capped Energy Index Fund (XEG)
The price of oil and natural gas was subdued for several years after the 2015 crash.
Oil producers stopped investing in equipment and wells, which lowered production.
After a global pandemic and an unexpected crisis in Eastern Europe plunged the world into an energy supply shock, oil producers are expected to generate more cash flow than they have in recent history.
Investors can bet on this theme with the iShares S&P/TSX Capped Energy Index Fund (TSX:XEG).
Over the past twelve months, this index fund has delivered a whopping 19% total return.
This year, the fund’s underlying oil and gas companies could boost dividend payments and buybacks.
That accelerates the total return of the fund.
The largest holdings in the fund are Cenovus, Suncor and Canadian Natural Resources.
All 24 holdings are expected to see substantial cash flows and profits this year.
If oil prices remain elevated for several years, this fund could be a top performer.
Investors may want to consider a little exposure to this sector to capitalize on macro movements.
XEG currently offers a dividend yield of 1.06% dividend yield.
5. iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (CDZ)
Some companies grow rapidly while others offer high dividends.
However, a small group of high-quality companies can achieve a balance of both.
They can deliver steadily rising dividends over several decades.
These dividend growth companies are excellent for long-term investors.
The iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (TSX:CDZ) tracks an index of companies that have boosted dividends every year for a minimum of five consecutive years.
The fund holds 94 stocks that meet this basic criteria.
At the moment, the fund offers a 4.08% dividend yield that is paid out on a monthly basis.
This dividend payout should steadily rise over time if the underlying companies can sustain their growth momentum.
Overall, CDZ should deliver better total returns than the rest of the stock market.
Since inception, CDZ has delivered a total return of 6.78% CAGR.
If that pace continues, any dollar invested today should be worth more than two dollars by the end of the decade.
Investors seeking steady growth and monthly payouts should keep an eye on this fund.
Key Criteria to Consider When Investing in Index Funds
Adding index funds to your portfolio is usually an excellent strategy.
However, you may need to consider the theme of the underlying index, the expense ratios, dividend payouts and weightage policy.
An index fund that invests in a speculative and volatile industry (such as biotech) may not be suitable for everyone.
Similarly, an index fund that offers negligible dividends may not be ideal for income-seeking investors.
Fees are another critical aspect of these funds.
An expensive fund with high management fees could erode your long-term performance.
Investors might also need to consider if the fund they pick is equal-weighted or market-cap weighted to ensure proper diversification.
If you’d like to learn more about investing in index funds, you can check out our guide explaining how to invest in index funds.
Frequently Asked Questions
- How do I buy an S&P 500 index fund in Canada?
There are several Canadian funds that track the S&P 500. The BMO S&P 500 Index Fund (TSX:ZSP) is a prime example that can easily be purchased on most brokerage platforms the same way you would purchase an individual stock.
- How are index funds taxed in Canada?
Index funds are taxed like regular stocks, which means any passive income or capital gains you derive from these investments could be subject to taxes. However, most index funds can be held in government-registered accounts such as the Tax-Free Savings Account (TFSA), which could help you mitigate these taxes.
- Which index fund is best in Canada?
The best index fund for you depends on your investment objectives, risk appetite and time horizon, there is no one size fits all ‘best; index fund.