The beauty of exchange-traded funds (ETFs) is that they allow investors to cover a lot of ground with a single investment. Although broad ETFs generally don't experience the hypergrowth returns you might achieve with a single outstanding company's stock, some funds have consistently outperformed the market.
If you're looking for an ETF that has shown it has the potential to create millionaires, consider the Vanguard Information Technology ETF (VGT +2.58%). Since its inception 20 years ago, it has averaged over 13% annual total returns. Over the past decade, the performance has been even more impressive, with an annualized total return surpassing 20%.
Past performances don't guarantee future results, but if we assume this trend continues, the ETF could carry investors who have time on their side to the seven-figure promised land.
If one takes the middle ground between the ETF's average returns from inception and the past decade (say, 16% annualized returns), a person who invested $500 monthly in it could see the value of their position cross the $1 million mark in around 23 years. With a more conservative projection of 13% annualized returns, they could do so in around 26 years.
The one sector leading the way for the U.S. market
S&P Dow Jones Indices (the joint venture behind the market's most well-known indexes) and MSCI have created a widely used system called the Global Industry Classification Standard, under which they classify all public companies. That system starts by grouping them into 11 major sectors:
- Communication services
- Consumer discretionary
- Consumer staples
- Energy
- Financials
- Health care
- Industrials
- Information technology
- Materials
- Real estate
- Utilities
Since the inception of the Vanguard Information Technology ETF in January 2004, the information technology sector has noticeably outperformed its counterparts. Here's how the sectors have performed over that span:
There has been the tech sector, and then there has been everything else -- especially over the past decade. These differences in performance might not be as pronounced in the future, but the tech sector isn't showing any signs of slowing down, which further boosts the appeal of the Vanguard Information Technology ETF.
New tech developments should help drive growth
The ETF holds stakes in more than 310 tech companies, ranging from well-established blue chips to newcomers looking to disrupt industries and innovate. This wide range of companies exposes investors to the relative stability of megacaps as well as the high-growth potential of emerging companies (though many of the megacaps have experienced high growth in recent years).
Although the ETF is fairly broad in terms of the number of its holdings, it's also weighted by market cap. Therefore, top tech companies account for a large portion of its value. As of April 30, these were its top 10 holdings and their share of its holdings:
- Microsoft: 17.28%
- Apple: 15.27%
- Nvidia: 11.89%
- Broadcom: 4.40%
- Salesforce: 2%
- Advanced Micro Devices: 1.96%
- Adobe: 1.60%
- Cisco Systems: 1.46%
- Accenture: 1.44%
- Oracle: 1.44%
It's not ideal that three companies account for more than 44% of the value of an ETF with more than 310 components, but this concentration reflects these tech giants' high performance and dominance in recent years. Still, it's worth noting that this concentration represents an added risk. If one of these companies underperforms, it would put a tangible drag on the ETF's performance.
The good news, though, is that the ETF's largest holdings operate in industries poised to experience significant growth in the coming years, especially with the advancements in AI. With cloud computing, cybersecurity, big data, the Internet of Things, and dozens of other technologies, there's a lot of innovation happening that should continue to drive growth for these top names.
One piece of the puzzle for a well-balanced portfolio
Regardless of how impressive Vanguard Information Technology ETF's returns have been (and can continue to be), investors must not forget the importance of diversification. It helps reduce the risks of investing and can help promote long-term growth.
Having your portfolio concentrated in one sector works when that sector is performing great, but the opposite is true when it experiences a down period. Unfortunately, it's not easy to predict when such declines will happen -- and attempting to "time the market" is usually a poor strategy.
The Vanguard Information Technology ETF should be part of a diversified portfolio, but ideally, it should not be the bulk of it. Use it to complement a broader ETF (like an S&P 500 index fund) or complement it with other sector-specific ETFs so that you wind up with exposure to more of the broad market. Never lose sight of why diversification has stood the test of time as a key pillar in investing.
