Buy 2 Vanguard Index Funds to Beat the S&P 500 in the Next Year, According to Wall Street

The median forecast among Wall Street analysts says the benchmark S&P 500 (^GSPC 1.18%) will advance 18% to 8,200 in the next year, according to FactSet Research.

As of February 10, only two stock market sectors are projected to outperform the S&P 500 during that period. The information technology and consumer discretionary sectors will add 33% and 22%, respectively, according to the median target prices set by analysts.

Investors can get exposure to those sectors with the Vanguard Information Technology ETF (VGT 1.47%) and the Vanguard Consumer Discretionary ETF (VCR 1.57%). Here are the important details.

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Vanguard Information Technology ETF: 33% upside implied by the median target price

The Vanguard Information Technology ETF tracks 320 stocks in the information technology sector, which includes three major segments: software and cloud services, technology hardware and equipment, and semiconductors and semiconductor manufacturing equipment. The top 10 holdings in the index fund are listed by weight below:

1. Nvidia: 17.4%
2. Apple: 14.9%
3. Microsoft: 12.1%
4. Broadcom: 4.4%
5. Palantir Technologies: 1.9%
6. Advanced Micro Devices: 1.7%
7. Oracle: 1.6%
8. Micron Technology: 1.6%
9. Cisco Systems: 1.5%
10. IBM: 1.3%

What could go wrong? Technology stocks often perform worse than the S&P 500 during drawdowns. The Vanguard Information Technology ETF underperformed the S&P 500 by 8 percentage points during the last market correction, and it underperformed by 9 percentage points during the last bear market.

Nevertheless, information technology was the best-performing market sector during the last decade. The Vanguard Information Technology ETF achieved a total return of 776% during that period, equivalent to 24% annually.

Here's the big picture: This Vanguard index fund has a relatively cheap expense ratio of 0.09%, and it's likely to perform well as artificial intelligence spending increases in the years ahead. Also, the current valuation of 39 times earnings is reasonable when Wall Street analysts expect technology companies in aggregate to report earnings growth of 24% annually through 2027.

Vanguard Consumer Discretionary ETF: 22% upside implied by the median target price

The Vanguard Consumer Discretionary ETF tracks 288 stocks in the consumer discretionary sector, which includes two segments: manufacturing and services. The manufacturing segment covers apparel, automotive, household, leisure, and textile products; the services segment covers hotels, restaurants, and retailers. The top 10 holdings in the index fund are listed by weight below:

1. Amazon: 21.1%
2. Tesla: 18.1%
3. Home Depot: 4.6%
4. McDonald's 3.2%
5. Booking Holdings: 2.6%
6. TJX Companies: 2.5%
7. Lowe's Companies: 1.8%
8. Starbucks: 1.4%
9. MercadoLibre: 1.3%
10. DoorDash: 1.3%

What could go wrong? Consumer discretionary stocks often perform worse than the S&P 500 during market drawdowns. The Vanguard Consumer Discretionary ETF underperformed the S&P 500 by 5 percentage points during the last market correction, and it underperformed by 7 percentage points during the last bear market.

Nevertheless, consumer discretionary was the fourth-best performing market sector during the last decade. The Vanguard Consumer Discretionary ETF achieved a total return of 311% during that period, equivalent to 15% annually.

Here's the big picture: This Vanguard index fund has a relatively cheap expensive ratio of 0.09%, and it's likely to perform well so long as the economy remains healthy. Also, the current valuation of 29 times earnings is tolerable when Wall Street anticipates consumer discretionary companies in aggregate will report earnings growth of 12% annually through 2027.

Investors need to manage concentration risk

The index funds discussed are very concentrated. Three stocks in the Vanguard Information Technology ETF (Nvidia, Apple, and Microsoft) account for 44% of its performance. Similarly, three stocks in the Vanguard Consumer Discretionary ETF (Amazon, Tesla, and Home Depot) account for 43% of its performance.

Investors with large positions in either fund should consider diversifying their portfolios. One strategy would be to purchase index funds that track the financials, industrials, and/or communications services sectors, all of which performed well during the last decade. A more defensive strategy would be to buy index funds that track the consumer staples, healthcare, and/or utilities sectors, which tend to outperform during economic slowdowns.