As 2025 got underway, I wrote an article referring to the Vanguard Russell 2000 ETF (VTWO 2.20%) as one of the best investments for 2025 and beyond. At the time, the benchmark small-cap index was approaching correction territory, due to market turbulence that hit smaller companies hard.
Well, the ETF delivered a total return of about 13% for the year, so it's not as if this was a disastrous call by any means. But my prediction was that the Russell 2000 would handily outperform the S&P 500, and that didn't happen last year, with the continued AI surge fueling an 18% return in the large-cap benchmark.
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Why was I so bullish on the Vanguard Russell 2000 ETF?
There were two basic components of my investment thesis a year ago. First, small-cap stocks were trading at their greatest valuation gap relative to large caps in more than 25 years. The average price-to-book ratio of a Russell 2000 component was 2.1, compared to 5.0 times book for the typical S&P 500 company.
Second, falling interest rates generally favor smaller companies. They tend to be more reliant on borrowed money than their larger counterparts, and as yields on "safe" instruments like bonds and CDs become less attractive, money flows back into the market and into "riskier" assets, particularly small-cap stocks.
Why I'm still a buyer of the ETF now
To be fair, I wasn't totally wrong with my bull case. After all, a 13% return in one year is solid, historically speaking. Plus, I ended the prediction article by clarifying that I wasn't just buying for the 2025 performance -- I liked the Russell 2000 as a long-term investment at that level.
I still believe the next decade will be better for small caps than for the S&P 500, so I'm still buying shares of the Vanguard Russell 2000 ETF in my portfolio. After all, the valuation gap between the two types of stocks has widened even further, and last time there was such a difference (the dot-com boom in the 1990s), small caps went on to outperform for more than a decade.
Not only that, but most experts believe interest rates will continue to trend lower for at least the next couple of years, plus the Trump administration is generally in favor of lower regulations on businesses, which can help small caps better compete with larger companies.
