Beginners: Canadian Do-it-Yourself Index Investors May Not Be Properly Diversified

Here’s why the S&P/TSX Composite Index (TSX:^GSPTSE) is not a suitable one-stop-shop index for passive investors.

| More on:

When it comes to portfolio diversification, most investors immediately think of diversifying across various sectors to reduce systematic risk. Sector diversification is arguably the most important form of diversification, but it’s not the only form.

Most investors would stop at sector diversification, completely neglecting geographic diversification and diversification across market caps in the process. Sure, it’s true that diversification loses its effectiveness after a certain point, and odds are, you’d be fine as long as you’re diversified across various sectors with at least 10 stocks in your portfolio. But as a Canadian investor, you’re doing yourself a great disservice by investing 100% of your capital into TSX or TSXV-traded securities, especially if you’re a passive investor who’s heavily invested in the S&P/TSX Composite Index (TSX:^GSPTSE). By being heavily invested in this index, not only would you not be geographically diversified, but you wouldn’t even be properly diversified across sectors.

There are perks to remaining invested domestically, including the Canadian dividend tax credit and potentially lower MERs, on average, but I’m sure you’d find that your returns over the last decade would have been abysmal versus what you’d get if you investing in emerging markets or even U.S. indices due to improper diversification.

I still believe Canadian investors should be invested in their own country, but preferably not through the Canadian index fund. The index includes a nice sample of many Canadian businesses across all sectors, including the few tech stocks that exist on the TSX; however, unlike many other indices, the TSX is not a suitable one-stop-shop investment index.

The TSX is heavily weighted towards the energy and financial sectors, leaving your portfolio lacking in “essential nutrients” (other sectors), including tech, healthcare, and consumer staples, all of which are scarce on the TSX. Tech stocks, such as BlackBerry Ltd. (TSX:BB)(NYSE:BB), are great names to own in your portfolio, but in a cap-weighted index, the exposure you’d get would be a mere drop in a bucket that’s essentially filled with oil.

If you’re still keen on staying primarily invested in Canada, but you want to be properly diversified across sectors and other geographies, you may find it worthwhile to roll up your sleeves to become an investor in individual stocks. That way, you can create your own diversified portfolio of TSX-traded stocks, ensuring that you’re properly diversified across all sectors, properly nourishing your portfolio with all the “essential nutrients” it needs to thrive over the long term!

Also, it’s also possible to obtain “indirect” exposure to foreign markets like Europe and the U.S. with various TSX-traded stocks, such as Alimentation Couche-Tard Inc. (TSX:ATD.B), which has essentially grown to become global name, despite having strong roots in Canada.

Bottom line

Being a do-it-yourself investor and constructing your portfolio with low-cost domestic index funds can save you a tonne of fees over the long haul, but if you don’t properly educate yourself, you could end up being undiversified without realizing it.

If you’re one of the investors who’s overexposed to the TSX index, you can either supplement your portfolio with foreign indices (hedged if you’re worried about currency risk), such as the S&P 500, construct your own portfolio of individual Canadian stocks, or do a combination of both.

Stay hungry. Stay Foolish.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Joey Frenette owns shares of ALIMENTATION COUCHE-TARD INC. The Motley Fool owns shares of BlackBerry. Alimentation Couche-Tard and BlackBerry are recommendations of Stock Advisor Canada.

More on Stocks for Beginners

rail train
Dividend Stocks

Best Stock to Buy Right Now: CN Rail vs CP Rail?

Both these railway stocks have a strong future outlook, but which offers more value, and which more growth?

Read more »

Group of people network together with connected devices
Tech Stocks

If I Could Buy and Hold Only a Single Stock, This Would Be it

If there's one industry that's already proven itself, it's this one. And this tech stock is proving again and again…

Read more »

A close up color image of a small green plant sprouting out of a pile of Canadian dollar coins "loonies."
Stocks for Beginners

What to Know About 2 Canadian Mining Stocks for 2025

Mining stocks can be a strong investment, or a bit of a wild ride. So where do these two top…

Read more »

calculate and analyze stock
Dividend Stocks

Outlook for Restaurant Brands International Stock in 2025

QSR stock has had a turbulent few years, but investors may not want to count out the stock just yet.

Read more »

Beware of bad investing advice.
Stocks for Beginners

Top 5 Stock Market Mistakes for New Investors to Avoid

New investors can better build their wealth by avoiding these top stock market mistakes.

Read more »

Investor reading the newspaper
Stocks for Beginners

Invest for Tomorrow: 3 TSX Stocks to Build Lasting Wealth

Want stability and long-term growth? These three TSX stocks have proven their worth time and time again.

Read more »

nuclear power plant
Stocks for Beginners

What to Know About Canadian Infrastructure Stocks for 2025

Infrastructure companies are strong long-term investments no matter the market, and these three Canadian stocks look primed to grow.

Read more »

Blocks conceptualizing Canada's Tax Free Savings Account
Dividend Stocks

Where to Invest Your $7,000 TFSA Contribution for Long-Term Gains

Whether it's infrastructure, real estate or tech, these three stocks offer a promising addition to your TFSA.

Read more »