Many people have achieved financial success through index investing. Buying broad-market funds and holding them for the long term takes a lot of the risk out of investing and has historically provided investors with reliable growth.
But what if you could take that approach and step it up a notch? What if you could enjoy those same benefits while adding minimal extra risk and raising the potential for returns? You can get all that by investing in the Vanguard Growth fund (NYSEMKT: VUG), and if you’re interested in passive investing with the potential for higher growth, you should check out this exchange-traded fund (ETF).
Why investors love index investing
Investing in the S&P 500 through an index fund or ETF is a smart move for most investors. There are many upsides to doing either instead of or in addition to choosing your own stocks. The best course for an individual investor is to build a diversified portfolio with some growth stocks, some value stocks, and some passive income-focused choices. An ETF with exposure to nearly all of the largest U.S. companies — and those are precisely what is to be found in the S&P 500 index — instantly gives investors that diversification.
If you have confidence in the U.S. economy overall, investing in an S&P 500 index fund will allow you to grow your money in tandem with the economy and the broad market over time.
It’s not easy to beat the S&P 500. In 2023, only 40% of actively managed large-cap mutual funds beat the market, and the last time a majority of funds beat the market was in 2009. And even then, the share was 52%, so almost half of them didn’t.
Legendary investor Warren Buffett has many times recommended that retail investors put money into ETFs that track the broader market. Even in the massive portfolio of stocks that he and his lieutenants have picked for Berkshire Hathaway, one can spot a couple of ETFs that follow the S&P 500.
Index investing, but better
It’s not easy to beat the market over time, but Buffett has, and so have certain ETFs. You can boost your chances for outperformance without adding tremendous risk by investing in a growth ETF like Vanguard’s. The Vanguard Growth ETF tracks the CRSP US Large-Cap Growth Index. Even though it’s called a growth fund, it’s more focused on large-cap domestic companies than riskier high-growth stocks. Its top holdings include the “Magnificent Seven,” but it also owns plenty of low-risk blue chips like Visa and Eli Lilly. It also has an ultra-low expense ratio of 0.04%.
This ETF holds about 200 stocks, which is still highly diversified, even though it’s not 500. It has an average price-to-earnings (P/E) ratio of 38, which is significantly higher than the S&P 500’s P/E multiple of 25. But that’s a moderate multiple for a growth fund.
The Vanguard Growth ETF has outperformed the S&P 500 over most time periods, including a 10-year annualized return of 14.7% vs. 12.5% for the S&P 500.
Sometimes it can be helpful to look at precisely how much money a difference of a couple of percentage points annually over time can add up to, rather than thinking about those gains in the abstract. For this example, imagine you’d invested $10,000 each in the Vanguard Growth ETF and an S&P 500 fund 10 years ago, and left it alone, reinvesting your dividends along the way.
Today, your Vanguard holding would be worth about $7,000 more than your S&P holding. That’s just one example, obviously. If you’d invested more money, or held for a longer time period, your gains would have compounded further, providing you with even greater results.
You might still want to keep some money in a broader index fund for lower risk and even greater stability. Low-risk diversification is a great strategy for successful long-term investing. But you may want to add higher-growth options like the Vanguard Growth Fund, and if you have to choose between the two and have some tolerance for risk, you may want to choose the growth option.
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Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway, Vanguard Index Funds-Vanguard Growth ETF, and Visa. The Motley Fool has a disclosure policy.
Forget the S&P 500: Buy This Incredible Growth ETF Instead was originally published by The Motley Fool
