Traditionally speaking, utilities were once known as "widows and orphans" stocks -- low-volatility stocks that are generally mature and pay a dividend. The theory was that their regulated nature and generally strong dividends generally provided reasonable and fairly reliable returns with what seemed like less risk than many other stock types.
These days, while utilities as a group may still retain some of those characteristics, individual utilities themselves can be much riskier. Pacific Gas & Electric was forced into bankruptcy reorganization, for instance, due to its role in California wildfires. Likewise, Hawaiian Electric Industries is under pressure due to what may have been its role in the recent Maui wildfires.
Add the massive investments that many will have to make to prepare for tougher rules on carbon emissions, and it's now much harder than it used to be to pick solid utility stocks. Fortunately, you don't have to pick a winner in utilities to get a shot at a decent return from investing in them. This is because there are now low-cost exchange-traded funds (ETFs) that let you buy a broad basket of utility companies in one transaction.
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Vanguard's entry into the fray
Well known for its low-cost index-tracking ETFs, Vanguard offers investors the Vanguard Utilities Index Fund (VPU -1.14%). With a 0.1% expense ratio, this fund has a very strong likelihood of passing on virtually all the returns of the underlying companies in the index to its owners.
The index it tracks is the MSCI US Investable Market Index (IMI)/Utilities 25/50, which tracks across all market capitalizations of publicly traded electric, gas, and water utilities based in the United States.
According to the fund's prospectus, as of the end of 2021, the Vanguard Utilities Index Fund provided investors an 11% annualized 10-year return, versus an 11.12% rate for the underlying index. That showcases how closely the fund has been able to track its benchmark, after its fees.
An even bigger utilities ETF
An even larger utilities ETF is the Utilities Sector Select SPDR Fund (XLU -1.09%). Like the Vanguard fund, the Utilities Sector Select SPDR fund carries a 0.1% expense ratio, but it tracks a slightly different index, the Utilities Select Sector index. The net result is a 10-year return as of June 30 of 9.25%, versus an index return of 9.41%.
The Utilities Sector Select SPDR Fund also invests in utilities companies that handle electric, natural gas, and water services. Either ETF would provide exposure to similar companies and, with low expense ratios, would pass on most of the underlying companies' returns to the fund owners.
The big benefit of the ETFs
The largest holding of the Utilities Sector Select SPDR ETF is NextEra Energy, which represents about 14.8% of the fund's holdings. The largest holding of the Vanguard Utilities Index Fund is also NextEra Energy, although it represents a slightly smaller 13.1% of that fund's holdings. In both ETFs, that's the only stock that makes up more than 10% of the total allocations.
Because of that split of holdings, with one purchase, an ETF buyer gets a fairly decent spread of investments across the industry. That way, if one of the companies in the sector runs into financial difficulty, an ETF investor would not be completely knocked out by it.
It's thanks to that built-in diversification within the sector you don't need to pick a winner among utilities if you want exposure to those types of companies. All you need to do is buy a low-cost index-based ETF, and you'll get returns about in line with the sector as a whole.
Get started now
While individual utility companies may no longer be the low-risk stocks they once were perceived as being, the overall sector itself still retains some of those characteristics. After all, we all still need to heat our homes, drink water, and in these modern times, use electric appliances to maintain modern comfort and conveniences. That makes the sector a reasonable place to go to seek out the type of dividend income that has made utilities such popular stocks for so long.
If you're nervous about owning individual utility stocks given the risks, but still want exposure to the sector as a whole, today is a great day to consider investing in such an ETF. After all, both these sector ETFs pay quarterly dividends, and if you want to get the income streams they provide as quickly as possible, you need to be a shareholder before their next ex-dividend dates. So get started now, and help yourself to the benefits of the sector, while protecting yourself from any one company's challenges within it.