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Bank stock quandary: Try to pick the best banks, or just buy them all.

A reader asked this question recently. He wanted to know the pros and cons of buying individual bank stocks versus a Canadian bank ETF. Let's dig into this using the BMO S&P/TSX Equal Weight Banks Index ETF (ZEB-T) and the shares of each of the Big Six bank. We'll keep track of all the contestants using Globeinvestor's Watchlist feature.

Watchlists offer one- and five-year annualized total returns, which include dividends. By both measures, ZEB struggles to be even a middling player. It holds all six big banks in equal proportion, a mix that for both of these timeframes has resulted in returns closer to the weak banks than the strong ones.

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ZEB's one-year total return was 24.2 per cent as of Monday, which compares to 28.7 per cent for National Bank of Canada, 27.3 per cent for Royal Bank of Canada, 25.6 per cent for Bank of Nova Scotia and 25.4 per cent for Bank of Montreal. Trailing ZEB were Toronto-Dominion Bank and Canadian Imperial Bank of Commerce, up 22.7 per cent and 19.3 per cent, respectively. Leading and laggard banks change positions in the five-year view, but ZEB occupies the same position: behind four banks and ahead of two.

Here's another argument against ZEB: Its comparatively high management expense ratio of 0.62 per cent eats into your dividend yield. The Big Six banks yield anywhere from 3.6 per cent to 4.4 per cent these days. Thanks to that MER, ZEB comes in at around 3.1 per cent.

The seemingly obvious answer to this reader's question is to buy individual banks rather than ZEB. But which banks? The difficulty of choosing future winners brings us back to the idea of buying ZEB. You'll trail the top bank stocks if you own ZEB over any time period, but you'll also avoid the weakest performers. It all comes down to your stock-picking chops. Can you choose bank stock winners? Would you, for example, have anticipated that National Bank would be the second weakest five-year performer, but No. 1 over the past year?

Bottom line, ZEB is for people who want to own bank stocks without the work of picking winners and losers. The experience of the past five years shows ZEB can easily be beaten, provided you pick the right stocks.

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