The Vanguard S&P 500 Index ETF (TSX:VFV) stands out as a favourite among Canadian investors aiming for exposure to U.S. stocks, primarily due to its low expense ratio of 0.09%. Its affordability makes it an attractive option for those seeking to invest in the S&P 500 Index.
However, VFV comes with certain nuances that could perplex investors regarding its performance if they’re not clued in. To ensure you’re fully informed and can navigate your investment in VFV wisely, here are three critical aspects you need to be aware of before making your investment.
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It is not currency hedged
VFV holds a U.S. Vanguard S&P 500 ETF, which in turn holds a variety of U.S. stocks. This connection subjects VFV to currency exchange rate fluctuations, impacting its performance in ways that can be either beneficial or detrimental.
For instance, should the U.S. dollar depreciate against the Canadian dollar, VFV might lose value, even if the S&P 500 Index itself performs well. Conversely, if the U.S. dollar appreciates against the Canadian dollar, VFV could see an increase in value beyond the actual performance of the S&P 500.
Therefore, it’s entirely feasible for VFV to remain stable on a day the S&P 500 Index sees gains, simply because the Canadian dollar strengthened, or for VFV to sustain its value even when the S&P 500 drops, thanks to a rising U.S. dollar.
While such currency effects tend to balance out over the long term, they can introduce unwanted volatility for short-term investors.
The dividend is reduced slightly
VFV’s current distribution yield, which stands at 1.08% as of April 10th, is net of a 15% foreign withholding tax on dividends from its underlying U.S. stocks.
This tax reduction is an inescapable aspect of investing in VFV due to the structure of its underlying U.S. ETF holdings. The U.S. levies this tax on dividends before they are distributed to Canadian investors, effectively reducing the amount you receive.
To bypass this foreign withholding tax, one could opt to invest in a U.S.-listed S&P 500 ETF within an RRSP, where the tax does not apply. However, the benefits of this strategy might be offset by the costs associated with currency conversion, making it potentially less advantageous.
It’s fairly risky
VFV, despite encompassing a broad range of U.S. stocks across all 11 sectors, remains fully invested in equities. As a result, it’s exposed to the inherent volatility of the stock market.
Currently, VFV exhibits an annualized standard deviation of 13.9%. This figure quantifies the fund’s volatility, indicating how much its value can fluctuate over a given time period. It’s a measure of risk and reflects the variability in the ETF’s returns.
For an investor holding VFV, this means you should be prepared and comfortable for the value of your investment to potentially swing by about 13.9% in either direction over the course of a year, under normal market conditions.
