Most investors dream of an investment that can deliver gains in both bull and bear markets. At minimum, it would be ideal to take advantage of the majority of the stock market's upward swings while mitigating downward exposure during corrections.
If this sounds like a compelling combination, you should strongly consider my favorite Vanguard exchange-traded fund (ETF) for 2026: the Vanguard Utilities Index Fund ETF (VPU +1.08%). There are two reasons in particular that it could be a huge winner this year.
1. Stocks look very expensive
I'm a huge fan of growth stocks with big upside potential. The unfortunate news is that the vast majority of promising growth stocks are trading at relatively high valuations right now. In fact, the entire stock market is trading at a nosebleed levels.
At least that's the case when looking at broad stock market indexes. The S&P 500, for example, currently trades at a price-to-earnings ratio (P/E) of around 30 -- its highest valuation in years.
NYSEMKT: VPU
Key Data Points
When stock markets are expensive, there can often be nowhere to hide. Utilities, however -- the businesses that the Vanguard Utilities Index Fund exclusively invests in -- look like relative bargains. The utility stocks in this Vanguard fund trade at an average P/E of just 21. That's around 30% cheaper than the S&P 500 overall.
To be fair, utilities have long traded at a historical discount to the market. These stocks typically show far slower growth than other types of businesses, especially exciting sectors like artificial intelligence. And right now, utility stocks are also historically expensive. In past market peaks, the utility sector traded at just 17 times earnings -- roughly a 20% discount to today's levels.
Given their lower growth, utility stocks can also struggle in bull markets. It's not that these stocks don't gain value in upward markets; for the most part, they do. It's just that the upside potential is typically less. After all, utility businesses specialize in things like electricity, water, and natural gas distribution. When markets spike, demand for these services usually doesn't spike in tandem.
But here's the thing: In downward markets, these stocks typically shine. That's because when markets dip, demand for utility services typically doesn't fall nearly as much, if at all. So when markets are historically expensive, investing in utility stocks can greatly protect your portfolio's downside without sacrificing upside potential. While we can't know the future, I'm betting the same downside protection will prove true during the next market downturn, even if that downside protection is partially blunted by the sector's historically high valuation. According to research from Fidelity, "Historically, utilities have displayed the least economic sensitivity among the 11 equity market sectors, as well as having low beta."
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2. Dividends can help you deploy cash advantageously
Utility stocks have another advantage apart from bear market protection: above-average dividend yields. Right now, the Vanguard Utilities Index Fund ETF has a total yield of around 2.74%. That may not sound like much, but its roughly double what the S&P 500 currently delivers in dividends.
This is a small advantage, but an advantage nonetheless, especially during a bear market. When markets are falling, extra cash becomes scarce. The ability to redirect cash dividends into beaten-down stocks is a rare opportunity. This Vanguard ETF allows you to do that better than broad market index funds.
Is the Vanguard Utilities Index Fund ETF perfect? Absolutely not. Over long stretches of time, expect it to lag broader index funds that track the S&P 500. Its current valuation is also nearly the highest its been in history. And while the dividend yield bests what the overall market can offer, it's still very much on the low end for the sector historically.
But when stock markets are trading at historical highs, ETFs like this one become attractive for those looking to hedge their investments without dumping equities entirely. In the event of a downturn, not only can you redirect dividends into falling stock prices, you also can cycle out of this relatively conservative fund into a more aggressive vehicle when the time suits you, all without sacrificing upside potential.
