One of the most effective ways to grow your wealth over time is to invest in low-cost index funds that track major benchmarks such as the S&P 500. Among the diverse universe of available funds, the Vanguard group stands out for its exceptional returns and low fees, thanks to its unique ownership model.
Unlike other fund companies, Vanguard is owned by its funds, which are, in turn, owned by investors. This means that Vanguard operates in the best interest of its shareholders and can offer high-quality exchange-traded funds (ETFs) with minimal costs.
The Vanguard Growth Index Fund (VUG +1.52%) is one of the most popular ETFs from this provider and has many attractive features for growth-oriented investors. It's a large-cap growth fund that has consistently achieved higher returns than the S&P 500 since it was launched in 2004.
With dividends reinvested, this Vanguard large-cap growth fund has beaten the benchmark S&P 500 by an impressive 166.7% over its 20-year existence. This is an incredible result, considering how hard it is to beat this major U.S. stock market indicator over a long period.
Image source: Getty Images.
However, before you decide to buy this Vanguard ETF, you should carefully weigh some crucial issues. The main one is how this fund fits into a well-balanced portfolio that aims for reasonable levels of capital growth but with some form of protection against potential economic shocks. Here is one way the Vanguard Growth Index Fund could be used to enhance a portfolio without making it too risky.
Meet the Vanguard Growth Index
In many ways, this ETF is essentially a more concentrated version of the S&P 500. Keeping with this theme, its top five holdings by weight in rank order (Apple, Microsoft, Amazon, Nvidia, and Google) are identical to the S&P 500.
However, these five tech stocks account for over 41% of the ETF's portfolio but only account for 23.4% of the S&P 500 index, at the time of this writing. So the Vanguard Growth Index ETF is a more aggressive growth vehicle than the plethora of ETFs tracking the S&P 500.
NYSEMKT: VUG
Key Data Points
Another major difference is this ETF only holds 208 stocks. Its lower diversification factor is the core reason behind its outperformance, relative to this benchmark U.S. stock index. But it also makes this Vanguard growth fund riskier.
Fitting this ETF into a medium-risk portfolio
One possible way to fit this ETF into a medium-risk portfolio is to consider its high correlation with the S&P 500 and diversify accordingly.
For example, a medium-risk portfolio that aims for above-average growth could allocate 30% of its capital to the Vanguard Growth Index ETF, instead of the S&P 500, to tilt the portfolio toward large-cap growth. The portfolio would also dedicate 30% to high-quality dividend stocks that screen as undervalued, and the remaining 40% to a mix of mid- and small-cap growth stocks/ETFs, bonds, precious metals, and cash. As a result, the portfolio would be tilted toward growth, but also have some built-in downside protection via its ownership in other asset classes less correlated with the performance of U.S. large-cap stocks.
Of course, this is not the only way to use this ETF in a medium-risk portfolio. Many other factors could influence the optimal asset allocation, such as the investor's risk tolerance, growth objectives, time horizon, and market conditions. The Vanguard Growth Index ETF can be a valuable component of a growth-oriented portfolio that follows the key principles of modern portfolio theory.
A word on the maximum growth approach
You can certainly own both the Vanguard Growth Index ETF and the S&P 500 in a portfolio geared for maximum growth, but you'll have to be willing to accept a high degree of volatility. Moreover, this ultra-high-growth approach is best suited for investors with a long-term horizon (20 years or more), due to the risks and volatility involved with owning two funds that are highly correlated in several regards.
A high degree of correlation between assets in a portfolio can lead to staggering declines in a down market. That shouldn't be a problem for investors with decades before retirement, but risk-averse investors would be wise to stick to the tenets of modern portfolio theory and own a basket of contrarian assets.
