If you're one of those investors drawn to index funds, good for you! Index funds have a lot going for them:
- A tendency toward extremely low fees.
- Nearly instant ownership of a host of stocks in the index being tracked.
- A solid performance that beats most actively managed stock funds.
Indeed, index funds can be all you need to generate your retirement savings.
There's a catch, though: Which index you're tracking matters a lot. For instance, if you think it's good to go with an index fund tracking the Dow Jones Industrial Average, you might want to think again. Here's a look at why, and a recommendation of an alternative (more impressive) index fund to consider.
What's wrong with the Dow?
The S&P 500 index is one of the leading indexes in America, and it monitors about 500 stocks. Together, they represent about 80% of the total value of the U.S. stock market. The Dow is just as well known (if not more so), but it tracks the performance of only 30 stocks. These include Amazon, Apple, IBM, Coca-Cola, and Walmart -- all of which are also in the S&P 500.
One of the most problematic things about the Dow index is that it's price-weighted, which means that its published value is an average of all its components' stock prices. So its higher-priced components, such as Microsoft (recent stock price: $425) will influence the index much more than its lower-priced components, such as Intel (recent price: $42). And that's only because of their stock prices, not because of their market dominance, growth prospects, cash generation, or any other metric.
A stock's price alone is not very meaningful -- a $10 stock might be very overvalued and ready to fall, while a $500 stock could be on its way to tripling within a few years.
Alternatively, the S&P 500, and many other indexes, are weighted by market capitalization, so that the bigger companies exert more influence on the index's value. That, too, can be problematic to some degree, which is why there are some indexes that are equal-weighted, giving every component equal influence, such as the S&P 500 Equal Weight Index.
Meet a magnificent ETF
Long-term investors interested in growth stocks and boosting their portfolio's performance should consider the Vanguard Growth ETF (VUG -0.20%), a market-cap-weighted index fund with an impressive track record and solid potential to keep performing well. It's an exchange-traded fund (ETF), meaning it trades like a stock, but it's also a mutual fund (VIGAX) for those trading within the Vanguard system.
Let's start with its track record, just to get your attention. The table below shows how the Vanguard Growth ETF has performed over time (based on total returns), comparing it to a simple S&P 500 index fund, the SPDR S&P 500 ETF:
|
Vanguard Growth ETF |
SPDR S&P 500 ETF Trust |
|
|---|---|---|
|
1 year |
38.8% |
29.6% |
|
3 years |
10.9% |
11.3% |
|
5 years |
17.9% |
15% |
|
10 years |
15.1% |
12.9% |
|
15 years |
17.3% |
15.6% |
Source: Morningstar.com.
Impressive, right? Keep a few things in mind, though. For starters, that big, fat one-year return of nearly 39% isn't to be expected very often, if at all. Also, you'll see that over the past three years, the Vanguard Growth ETF underperformed the S&P 500. And its future performance is in no way guaranteed to follow past performance.
More about the Vanguard Growth ETF
The Vanguard Growth ETF tracks the CRSP U.S. Large Cap Growth Index, which represents the growth style of the top 85% of U.S. equity market capitalization.
The ETF has an expense ratio (an annual fee) of 0.04%, which is quite low, costing $4 per $10,000 invested. Since it holds many different stocks, plenty of which pay dividends, it passes those dividends on to shareholders. The ETF's dividend yield is about 0.5%. The strong stock performance of late has depressed the dividend yield.
The Vanguard Growth ETF's portfolio features 208 stocks, with a median market value near $715 billion. So it's focused on large-cap companies -- and relatively fast-growing ones.
Since it's weighted by market cap and includes many of the biggest tech stocks -- such as Apple, Microsoft, and Nvidia -- the overall portfolio is very weighted toward tech stocks. It had 56% of its holdings in the technology sector (and all of the "Magnificent Seven" stocks, too). Here are the ETF's top 10 holdings at the end of February:
- Microsoft: 12.84% of the fund
- Apple: 11.15%
- Nvidia: 7.75%
- Amazon: 6.87%
- Meta Platforms: 4.54%
- Alphabet (Class A): 3.42%
- Alphabet (Class C): 2.84%
- Eli Lilly: 2.69%
- Tesla: 2.28%
- Visa: 1.81%
So consider the Vanguard Growth ETF if you would like to quickly gain exposure to 208 relatively fast-growing stocks. If it doesn't appeal to you, know that there are many other solid ETFs out there, including plenty of fast-growing ones.
