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3 Index Funds I Predict Will Beat the Market in 2021

By Matthew Frankel, CFP® - Feb 3, 2021 at 7:16AM

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If you think the economy will normalize in 2021, these three ETFs should be on your radar.

Obviously, nobody has a crystal ball that can predict how the stock market, or any part of it, will perform over any certain time interval. After all, in March 2020, who would have predicted that the market would have ended the year higher than where it started?

That said, there are some stocks that have been major beneficiaries of the stay-at-home economy, and others that could stand to benefit more than others as the COVID-19 pandemic starts to (hopefully) wind down in 2021. With that in mind, there are some index fund ETFs that could significantly outperform the S&P 500 this year, and here are three I'm highly optimistic about.

Two businessmen looking at financial data on monitors.

Image source: Getty Images.

One of the worst-performing sectors in 2020

Real estate was one of the worst performing parts of the stock market in 2020. In fact, the Vanguard Real Estate ETF (VNQ -0.62%) produced a negative 4.6% total return for the year, dramatically underperforming the 18% total return in the S&P 500.

To be sure, there were good reasons for the poor performance. Many real estate investment trusts, or REITs, own properties that depend on people being willing and able to go places -- think hotels, malls, shopping centers, etc.

However, REITs could also be some of the biggest beneficiaries as the pandemic (hopefully) comes to an end in 2021. There is tremendous pent-up demand to travel, shop, and spend money on experiences, and this could translate to a big boost to the real estate sector.

Large stocks rallied in 2020, while many small caps were left behind

The second index fund I think could beat the market in 2021 is the iShares Russell 2000 ETF (IWM -1.01%).

For the most part, the largest U.S. companies held up quite well during the pandemic. Apple (NASDAQ: AAPL) saw strong demand for its products, Microsoft (NASDAQ: MSFT) didn't experience much sales disruption, and Amazon (NASDAQ: AMZN) was one of the biggest beneficiaries of the retail disruption.

However, most of the so-called "reopening stocks" that could benefit most from a return to normalcy, aren't among the largest companies in the market. Think of hotel stocks like Ryman Hospitality Properties (NYSE: RHP), entertainment stocks like Dave & Buster's (NASDAQ: PLAY), and mall operators like Tanger Factory Outlet Centers (NYSE: SKT). (Note: All three of these combined are about 0.3% of Apple's size.)

Sure, there are some large-cap companies that could benefit from reopening. Marriott International (NASDAQ: MAR) is one name that comes to mind. But the point is that the world of small caps is full of reopening stocks, while the mega-cap world has disproportionately few.

Banks could benefit from reopening

Finally, another sector that has been beaten down in the pandemic is the financial sector, so I think the Financial Select Sector SPDR ETF (XLF -0.56%) could outperform as the world gradually returns to normal.

Banks were hit hard by the pandemic for two very good reasons:

  • While the banking business is complex, the main way banks make their money is by charging interest on loans. With a record-low interest environment, bank profits have been under pressure.
  • The pandemic creates an elevated level of default risk, as unemployed borrowers could run into trouble paying their loans.

However, both of these could change as 2021 goes on. We're already starting to see interest rates tick higher, and I'd expect more of the same as the pandemic gradually ends. And as unemployment starts to drop toward pre-pandemic levels, the default risk faced by lenders is likely to decline with it.

All of these are great long-term picks no matter what happens in 2021

As a final thought, while I think all three of these have a good chance at beating the market in 2021, I'm not saying that you should plan to hold these for a year and then cash in. All three are excellent index funds that can create long-term wealth in your portfolio.

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Stocks Mentioned

The Select Sector SPDR Trust - The Financial Select Sector SPDR Fund Stock Quote
The Select Sector SPDR Trust - The Financial Select Sector SPDR Fund
XLF
$31.73 (-0.56%) $0.18
iShares Trust - iShares Russell 2000 ETF Stock Quote
iShares Trust - iShares Russell 2000 ETF
IWM
$170.69 (-1.01%) $-1.75
Vanguard Specialized Funds - Vanguard Real Estate ETF Stock Quote
Vanguard Specialized Funds - Vanguard Real Estate ETF
VNQ
$91.28 (-0.62%) $0.57

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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