ETFs
You can do better than the S&P 500: buy this ETF instead
It’s hard to beat the S&P 500, but this ETF has been doing it for a long time.
It’s not easy to beat the market. Only 8% of active large-cap fund managers outperformed S&P500 over the last 15 years. Those who simply invested in an S&P 500 index fund therefore beat 92% of professional fund managers.
If you want to invest successfully, one of your best options is to stick with the S&P 500. But what if you want even more growth? THE Vanguard Small Cap ETF (V.B. -1.37%) might be your best bet.
Always try to minimize this one thing
When it comes to investing in exchange-traded funds (ETFs), there is one thing you should try to minimize: the spending rate. This is what the fund charges you each year to invest in it.
Expense ratios vary widely. Some charge you 1-2% per year, while others charge as little as 0.01%. If you lose 1% or 2% of your assets to fees each year, that will significantly reduce your returns compared to if you kept 99.9% of your money from year to year.
Expenses are one of the main reasons why most professionally managed funds underperform the market over the long term. As an index fund guru Jack Bogle “Investors as a group must underperform the market because the costs of participation – largely operating expenses, advisory fees and portfolio transaction costs – are a direct deduction from market performance. “
Bogle founded The Vanguard Group in 1975 to help ordinary investors avoid the high fees charged to them by other managers. Today, the company’s ETFs are among the most profitable options available. And one in particular – the Vanguard Small-Cap ETF – has outperformed the S&P 500 for decades, even after accounting for expenses.
This ETF can outperform the S&P 500
The S&P 500 is a large-cap index. Its portfolio is made up of the 500 largest publicly traded companies in the United States. The index therefore does not include small-cap companies, which have historically outperformed larger-cap stocks.
In general, small-cap stocks have shown more volatility over the decades than large-cap stocks. The reason makes sense: As small businesses, these businesses have less scale, less access to capital, and are generally less distressed. This high volatility, however, has generated above-average gains for investors willing to take on additional risk.
According to Wellington Management, over a 10-year investment period, small caps beat large caps two-thirds of the time. Since 1927, this outperformance would have added 2.87% of annual returns to an investor’s portfolio.
The Vanguard Small-Cap ETF is one of the best ways to invest in small-cap stocks. The fund tracks the CRSP US Small Cap Index, which includes 1,417 small-cap stocks. Its expense ratio is just 0.05%, compared to an average of 0.99% for similar funds.
There is a problem, however: small caps have underperformed large caps recently. This is a rare phenomenon. From 2005 to 2020, for example, the Vanguard Small-Cap ETF beat the S&P 500 by several percentage points.
Since then, however, it has lagged the market by 38%. This gap between small caps and large caps is the widest it has ever been since the dotcom bubble. “On a forward price-to-earnings basis, small caps trade at 14x, compared to large caps at 20x, a 30% discount,” Wellington Management explains.
There’s no secret to beating the S&P 500: small caps have been doing it for a long time. If you want to beat the market over the coming decade, your best option appears to be a small-cap ETF like Vanguard’s, which offers instant exposure, low fees, and a historically low valuation.
Ryan Vanzo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Index Funds-Vanguard Small-Cap ETF. The Motley Fool has a disclosure policy.