Is the Vanguard Growth ETF the Simplest Way to Consistently Beat the S&P 500?

Beating the S&P 500 (SNPINDEX: ^GSPC) over an extended period of time is no easy task. Just 8% of active large-cap U.S. equity stock funds outperformed the index over the last 20 years.

One of the most effective ways to beat the index is to have a few winners that do really well. Buying a stock like Amazon 20 years ago would have produced monster returns, allowing investors to take an otherwise mediocre portfolio and transform it into an elite one.

Having outsized positions in large-cap growth stocks has been the secret sauce for beating the S&P 500 over the last decade, which is exactly what the Vanguard Growth ETF (VUG -2.10%) aims to do. Here's why the exchange-traded fund (ETF) could continue to do well over the long term.

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The Growth ETF gains are driven by just three stock market sectors

The Vanguard Growth ETF has a 0.04% expense ratio compared to 0.03% for the Vanguard S&P 500 ETF (VOO -1.67%), which is just a $1 difference for every $10,000 invested. So there's essentially a negligible cost to choose the Growth ETF over the S&P 500 ETF.

As you can see in the following table, the Growth ETF has crushed the S&P 500 over the last decade -- largely thanks to outperformance periods in 2017, 2020, 2023, and 2024.

Data source: YCharts. YTD = year to date. 

You'll notice that the Growth ETF fell much more than the S&P 500 in 2022, but that decline was more than made up for with outsized gains in many other years. Even when factoring in the S&P 500's higher dividend yield, the total return for the Vanguard Growth ETF is up 353.4% over the decade compared to 264.2% for the Vanguard S&P 500 ETF -- which is the difference between turning $10,000 into $45,240 versus $36,420 with no extra effort.

If the technology, communications, and consumer discretionary sectors continue to outperform the S&P 500, so will the Growth ETF. The Growth ETF has a combined weighting in these sectors of 80.1% compared to 53.3% for the S&P 500. So while the S&P 500 has become more concentrated in these sectors, the Growth ETF takes it to a whole new level by being drastically underweight in financials, healthcare, energy, consumer staples, materials, real estate, and utilities. Both sectors have roughly equal exposure to industrials -- which is cyclical and somewhat of a blend between growth, income, and value.

Reinvesting excess profits rather than distributing them can accelerate earnings growth

The Vanguard Growth ETF is betting big on just a handful of names, with roughly two-thirds of the fund concentrated in just 15 companies -- Nvidia, Microsoft, Apple, Amazon, Alphabet, Meta Platforms, Broadcom, Tesla, Eli Lilly, Visa, Mastercard, Netflix, Costco Wholesale, and Palantir Technologies. These companies have contributed a disproportionate amount of gains to the S&P 500 compared to the average S&P 500 holding. And since the Growth ETF is overweight in these names compared to the index, it has benefited even more from their outperformance.

The valuations of many of these companies are significantly higher than they used to be, which may lead some investors to wonder how much longer their outperformance can last before they revert to the mean. While it's easy to look at the price action of these companies and say they are overvalued, a better question is to ask what is stopping these companies from continuing to beat the market? Or even more specifically, what's holding these companies back from growing earnings at an above-average rate, therefore justifying higher stock prices?

At their core, what separates growth stocks from value stocks is capital allocation. A stodgy, mature business like Coca-Cola will sometimes acquire new drinks or invest in organic growth. But the opportunities are limited. So management prioritizes returning excess profits to shareholders through dividends, and to a lesser extent, stock repurchases, whereas many top growth stocks have compelling opportunities in artificial intelligence, cloud computing, robotics, e-commerce, media, networking, electronics, and more. These end markets have been lucrative for companies that can allocate capital effectively and innovate.

Amazon is famous for taking cash flow and plowing it back into growth initiatives. Amazon's track record is riddled with failures, but also major successes -- such as becoming the market leader in cloud computing and continuing to expand its e-commerce empire. By investing in ideas and maintaining a strong balance sheet, Amazon can afford to take risks and ride out downturns. Investors aren't always happy with this risk-taking, as Amazon fell 25% or more from its all-time high three times in the last 10 years (February 2016, December 2018, and over 55% in December 2022). In sum, the price for outsized gains is often high volatility, which can work in favor of risk-tolerant investors with long-term time horizons.

The Growth ETF remains a top buy now

There's no guarantee that the Vanguard Growth ETF will continue to outperform the S&P 500, but it has been one of the simplest ways to beat the index.

The outperformance hasn't been a fluke, as the index bets big on leading companies that pour resources into growing their future earnings rather than directly returning capital to shareholders. That strategy should continue to produce solid gains over the long term, but investors may want to temper their expectations in the near term, given elevated valuations.

I expect the Vanguard Growth ETF to outperform the S&P 500 ETF over the next decade, making it a more attractive option for long-term investors. However, the Growth ETF could easily underperform the S&P 500 over the short term, so it's only worth approaching the fund if you have the time horizon needed to endure volatility.