Invest in blue chip US stocks? Buy this index ETF instead

The United States has excellent blue chip stocks trading in its market. These large-cap companies have excellent fundamentals, with solid business models, a long history of share price appreciation, solid dividend growth and good competitive advantages.

Canadian investors should seriously consider making these blue chip stocks the backbone of the US equity portion of their portfolio. However, choosing which to buy and keep can be tricky. Keeping up with the news, rebalancing, and staying on top of earnings reports can be tiring.

Fortunately, there are a variety of exchange-traded funds (ETFs) that make stock picking simple. For very low and effortless fees, you can own an ETF that holds 30 of the largest and most traded stocks in the United States.

Which index to follow?

When we think of the US market, we often default to either the S&P 500 Index or the NASDAQ 100 Index. Both of these indexes are very popular and hold some of the best performing US companies. However, they have both become tech and growth heavy in recent years.

There is an alternative in the Dow Jones Industrial Average (DJIA). First published in 1896 and initially comprising 12 companies, the DJIA has evolved into the world’s most recognizable stock market indicator and the most widely quoted indicator of US stock market activity.

Currently, the DJIA holds a total of 30 stocks, all leaders in their respective industries with the common trait of sustained earnings performance over a significant period of time. The DJIA is a price-weighted stock index, which means that the stocks that compose it are held in proportions based on their price and not on market capitalizations, like other indices.

Current notable underlying stocks include walmart, waltz disney, Coca Cola, Home deposit, Microsoft, Goldman Sachs, McDonald’s, Visa, Boeing, Apple, Johnson & Johnson, 3M, and JP Morgan Chase & Co.representing a diverse and balanced mix of sectors.

How do we buy the Dow?

Buying DJIA usually requires converting CAD to USD and buying a US ETF. If you are unfamiliar with Norbert’s Gambit, currency conversion costs could be high. However, Canadian fund managers like BMO Global Asset Management released ETFs that track the DJIA in CAD.

Our top candidate here is BMO Dow Jones Industrial Average Hedged to CAD ETF (TSX: ZDJ). ZDJ seeks to replicate the performance of the ADI, net of fees, and with exposure to the US dollar, it is hedged back to the Canadian dollar.

ZDJ will cost you a management expense ratio (MER) of 0.26% to hold, which is typical for a US equity index ETF in Canada. Being made up of blue-chip companies, ZDJ also pays out a respectable dividend yield of 1.50%. This return already reflects a 15% reduction due to foreign withholding taxes on US assets for Canadian investors.

ZDJ is hedged into currencies using currency derivatives. Theoretically, this means that the value of ZDJ will not be affected by fluctuations in the CAD-USD and should follow the DJIA closely. In practice, the nature of the futures contracts used and the imperfect way in which they are rolled over introduce tracking error over time.

We see that since inception, ZDJ has closely tracked the DJIA but has underperformed by more than 1% CAGR. Over a long period, currency fluctuations actually reduce volatility and increase returns. When hedged, you lose that advantage and incur additional tracking error, leading to long-term underperformance.

The insane takeaway

If you want an absolutely hands-off approach to your US equity portfolio, ZDJ is the way to go. For a small annual fee, you get the performance of the top 30 stocks in the US market.

You’ll never have to worry about rebalancing or monitoring holdings, trying to figure out which stock will do well or badly. Set dividends to be automatically reinvested and enjoy watching your compound earnings!

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