Investing in individual stocks can make some investors nervous due to the amount of necessary research and the risk associated with volatility in the market. One way to quiet those nerves is to place your money into exchange-traded funds that follow a market or sector index and are managed by a financial institution. Each ETF holds positions in a group of stocks and can be traded in real-time, just like stocks.
Three healthcare ETFs that provide long-term investors with diversification, along with growth opportunities to outpace the S&P 500, include Vanguard Health Care ETF (VHT 0.03%), Blackrock iShares U.S. Healthcare Providers ETF (IHF -0.35%), and Blackrock iShares U.S. Medical Devices ETF (IHI 0.47%).
Image source: Getty Images.
1. Vanguard goes heavy on pharma, and light on expenses
The average expense ratio for ETFs has trended downward since 2008, driven by an injection of new ETFs on the market, giving investors an opportunity to increase their gains. But even at an average rate of 0.18% for asset-weighted funds, Vanguard comes in lower at 0.10%. With no minimum investment and a low expense ratio, it removes potential front-end obstacles that might scare away some investors.
This healthcare ETF also provides investors with an expansive diversification of stocks within the sector, including companies that sell medical products, services, equipment, and technology. The aim is to track the performance of a benchmark index, but 25% of the holdings are weighted toward pharmaceuticals. Moreover, 44% of its total assets are in its top-10 holdings, including Abbott Laboratories, AbbVie, and UnitedHealth, strong companies to hold for the long term.
Because the fund aims to track the healthcare index as a whole, it should continue to benefit from two growth areas. First, the pharmaceutical market is projected to grow at a 5.7% compound annual rate through 2026. Second, the population of people reaching age 65 over the next 10 years is expected to increase, leading to more spending on Medicare and Medicaid services.
Topping off the benefits of this ETF is a 1.14% dividend yield, which amounted to a $3.05-per-share distribution in dividends for 2021, and leads the pack of these three ETFs. A 15% average annualized return over the past 10 years is impressive as well.
2. Blackrock's U.S. Healthcare Providers ETF has a strong record
When long-term investors look to build out a portfolio, it's a good practice to compile a few investments that serve with consistency to support a foundational base. This ETF has provided positive returns in 13 of the 14 years since its inception.
Comparing it to the Vanguard healthcare ETF, there are some similarities and some trade-offs. Similarities include UnitedHealth as a top holding, which has been a rocket ship of growth, and has the right stuff to keep it going. But the rest of the top holdings are led by healthcare providers, including pharmacy market leader CVS. At the same time, its average annualized return of 17.3% over the past 10 years exceeds that of the Vanguard ETF.
The minor trade-off to the higher returns is that this ETF carries an expense ratio of 0.42%, which more closely resembles the 0.47% average of a simple, non-asset-weighted ETF. This basically means you're paying more for your gains.
But when the returns average 2% higher per year than Vanguard's ETF, they can make up for that higher expense ratio -- assuming that this winning streak can continue. And the heavier reliance on healthcare providers, as opposed to pharmaceuticals, can provide balance when letting both ETFs work in tandem for your portfolio.
3. Blackrock's U.S. Medical Devices ETF is well worth a high expense ratio
A third healthcare ETF for a solid portfolio could be the Blackrock U.S. Medical Devices ETF. If it's higher returns you're looking for from your ETF, you'll find it here, at a 19% average annualized total return over the past 10 years compared to the S&P 500 Healthcare average of 15.9%.
But like Blackrock's healthcare provider ETF, this medical devices-focused ETF has a heavy 72% of its total assets in the top 10 holdings, making it riskier than an ETF that is more broadly spread out. Other trade-offs to its higher returns include a higher 0.42% expense ratio and a slightly lower consistency rate of years with positive returns. It also delivers a lower dividend compared to each of the other two ETFs highlighted, at only 0.33%.
Holdings like Abbott Labs, Intuitive Surgical, and Medtronic have helped pace this large-growth ETF. It should benefit from a projected compound annual growth rate of 5.4% for the medical devices market through 2028, driven by such advancements in technology as artificial intelligence and robotics.
How does the S&P average match up?
The chart below shows the 10-year annualized return for each of these three ETFs compared to that of the broader S&P 500 and S&P 500 Healthcare indices. As you can see, both S&P averages fall below all three of these healthcare-focused ETFs.
While all three could be good additions to your portfolio, each may serve its purpose depending on your investment stage. Younger investors may opt to go with a higher-risk approach for higher potential annual returns, whereas someone closing in on retirement may want to go with an ETF that can deliver more consistency with less risk. Meanwhile, a higher-dividend-paying ETF can help generate some quarterly income and benefit investors at all stages.
