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Avoid financials overload: Watch how you pair up your ETFs

Financials have been spectacular wealth generators over the years, but they’re no more invulnerable to a correction than any other sector.

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The strength of financial stocks in the past year means it's time to look at whether you're overexposed to the sector.

ETF investors, be on the lookout for pairings of funds that can give you an alarmingly high weighting to financials. Example: Combining a broad Canadian equity ETF – say, iShares Core S&P/TSX Capped Composite Index ETF (XIC) – with a Canadian dividend fund.

Financials are the second-best-performing sector on the S&P/TSX composite index over the past 12 months, with a gain of 22.4 per cent. As a result, the shares of banks, insurance companies and investment firms now account for about 35 per cent of the index. That's a lot, but index investing is about taking the market as it comes. History has shown you can outperform a lot of money managers by tracking the index using a low-cost exchange-traded fund.

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Where you can run into trouble with financials is to partner a broad Canadian equity ETF with one of several Canadian dividend ETFs with a big weighting in the sector. Examples are the iShares Canadian Select Dividend Index ETF (XDV), with almost 62 per cent of its portfolio in financials and the Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY), with 64 per cent of its portfolio in financials. The PowerShares Canadian Dividend Index ETF (PDC) recently rebalanced its portfolio and the financials weighting has declined to 29 per cent from 43 per cent.

If you used XIC and XDV in equal proportions, you'd end up with about 50-per-cent exposure to financials in the Canadian equity portion of your portfolio. That's the average of the 35-per-cent weighting for XIC and the 62 per cent for XDV. Financials have been spectacular wealth generators over the years, but they're no more invulnerable to a correction than any other sector. That's why you have to be careful in combining Canadian equity and dividend ETFs.

Here are a few Canadian dividend ETFs with comparatively low financials exposure:

  • The BMO Canadian Dividend ETF (ZDV) has 35.6 per cent in financials.
  • The iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (CDZ) has just under 23 per cent of the portfolio is in financials.
  • The First Asset Active Canadian Dividend ETF (FDV) has 25.5 per cent in financials.
  • The First Trust AlphaDEX Canadian Dividend ETF (FDY) has 21.4-per-cent exposure to financials.
  • The Horizons Active Canadian Dividend ETF (HAL) has just over 19 per cent in financials.
  • The Purpose Core Dividend fund (PDF) has just 14.7-per-cent financials.

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