Why Index Investing Works

Investing can often seem daunting, especially with the myriad of options available. However, one strategy has consistently proven effective for both novice and seasoned investors: index investing. By purchasing total market ETFs and one-fund solutions, you can gain exposure to a broad spectrum of global stocks, thereby minimizing risk and diversifying your portfolio.

The Power of Index Investing

Index investing involves creating a portfolio that mirrors a specific market index, such as the S&P 500. This passive investment strategy offers several key advantages:

• Diversification: By investing in an index fund, you’re effectively purchasing a small piece of a wide array of companies across various sectors and geographies. This broad exposure helps mitigate the impact of poor performance from any single investment.
• Cost Efficiency: Index funds typically have lower expense ratios compared to actively managed funds. This is because they require less hands-on management, resulting in reduced fees for investors.
• Consistent Performance: While individual stocks can be volatile, index funds aim to replicate the performance of the overall market, which has historically trended upward over the long term.

Total Market ETFs and One-Fund Solutions

For Canadian investors, several notable options in the realm of total market ETFs and one-fund solutions include:

• VFV (Vanguard S&P 500 Index ETF): This ETF seeks to replicate the performance of the S&P 500 Index, providing exposure to 500 large-cap U.S. companies. It’s an excellent choice for investors looking to focus on the U.S. market.
• VGRO (Vanguard Growth ETF Portfolio): VGRO offers a diversified mix of approximately 80% equities and 20% fixed income, targeting investors seeking long-term growth with a moderate level of risk. The equity portion includes Canadian, U.S., international developed, and emerging market stocks.
• VBAL (Vanguard Balanced ETF Portfolio): Aiming for a balanced approach, VBAL allocates about 60% to equities and 40% to fixed income. This ETF is suitable for investors desiring a blend of growth and income through a globally diversified portfolio.
• XGRO (iShares Core Growth ETF Portfolio): Similar to VGRO, XGRO provides exposure to a mix of global equities and fixed income, with a focus on growth. It offers a slightly different regional allocation, with a higher emphasis on U.S. equities.
• XBAL (iShares Core Balanced ETF Portfolio): XBAL offers a balanced mix of global equities and fixed income, aiming to provide long-term capital growth and income. It’s designed for investors seeking a middle ground between growth and income.

For the fixed income portion of a passive portfolio, consider the following ETFs:

• VAB (Vanguard Canadian Aggregate Bond Index ETF): This ETF provides exposure to a broad range of Canadian investment-grade bonds, including government and corporate bonds.
• XBB (iShares Core Canadian Universe Bond Index ETF): XBB seeks to replicate the performance of the FTSE Canada Universe Bond Index, covering a wide spectrum of Canadian bonds.

Performance Overview

While past performance is not indicative of future results, it’s insightful to examine how these ETFs have performed historically:

• VFV: Over the past five years, VFV has delivered an annualized return of approximately 11.61%, closely mirroring the performance of the S&P 500 Index.
• VGRO and XGRO: Both ETFs have shown strong performance since their inception. For instance, in 2019, VGRO returned 17.66%, while XGRO returned 17.96%. In 2020, VGRO returned 10.89%, and XGRO returned 11.42%. It’s important to note that these figures can fluctuate based on market conditions.
• VBAL and XBAL: These balanced ETFs have also provided solid returns, reflecting their diversified holdings. For example, in 2020, VBAL returned approximately 10.30%, while XBAL returned around 10.70%. These returns are indicative of their balanced approach to equities and fixed income.

The Importance of Staying Invested

One of the fundamental principles of successful investing is maintaining a long-term perspective. Markets will inevitably experience fluctuations, but staying the course can lead to substantial benefits:

• Compounding Returns: Reinvesting dividends allows your earnings to generate additional earnings, leading to exponential growth over time.
• Mitigating Market Volatility: By remaining invested during market downturns, you position yourself to benefit from subsequent recoveries, which have historically outweighed periods of decline.

A study highlighted in The Times demonstrated that over a three-year period, the FTSE 100 index delivered returns comparable to the tech-heavy Nasdaq but with significantly less volatility. This underscores the value of a diversified, steady investment approach.