One of the best innovations in investing is the Exchange Traded Fund (ETF), an investment vehicle that allows anyone to easily buy shares of a fund that owns a group of related stocks, often in an index.
Vanguard founder Jack Bogle is credited with creating one of the first index funds, a mutual fund that paved the way for the popular Vanguard 500 Fundwhich the S&P500.
Today, Vanguard remains one of the most popular ETF managers, offering investors dozens to choose from. Let’s take a look at one worth investing in and one to avoid right now.
One Vanguard ETF to Buy Now
The Vanguard ETF worth buying right now is the Vanguard Financials ETF (NYSEMKT: VFH)which tracks the MSCI US benchmark of large, mid and small cap stocks in the financial sector.
Few ETFs are as cheap today as the Vanguard Financials ETF. The fund currently trades at a price-to-earnings (P/E) ratio of 16.6, compared to 29 for the Vanguard 500 ETF, meaning the S&P 500 is currently about 60% more expensive.
Bank stocks tend to have low valuations even in a bull market because their growth is closely tied to the economy and they are cyclical, meaning they are highly vulnerable to economic slowdowns or recessions.
Falling interest rates can create headwinds for banks because they tend to put pressure on net interest margins, or the difference between the interest paid on loans and other assets and the interest paid on deposits. But overall, lower interest rates should be a net positive as it stimulates lending and economic growth, reigniting the investment banking market for initial public offerings and M&A deals. Meanwhile, an improving economy and falling interest rates will also lower the risk of credit losses, boosting profits.
The Vanguard Financials ETF is also much more than bank stocks. The top 10 investments include those of Warren Buffett Berkshire Hathaway, Visa, MasterCard, S&P Global, American ExpressAnd Progressive.
The Federal Reserve appears on track to achieve the soft landing it aims for, meaning the economy could be poised for strong, steady growth in the coming years. That should benefit financial stocks, both as a company and as perceived by investors, and would support multiple expansions. Meanwhile, falling interest rates could lead to an increase in demand for mortgages, auto loans and other consumer financial products.
One Vanguard ETF to Avoid
The Vanguard Financials ETF looks like a good buy because it trades at a discount to the S&P 500 and should benefit from economic tailwinds.
The Vanguard Consumer Staples ETF (NYSEMKT: VDC)On the other hand, it looks expensive, and the economic conditions that have supported the sector are changing.
Investors tend to favor consumer staples such as Coca-cola And Procter & Gamble in tough economic times when consumers buy these types of products regardless of what the economy is doing, effectively making them recession proof. The downside, however, is that upside potential during economic expansions is limited.
Currently, the Consumer Staples ETF trades at a price-to-earnings ratio of 25, making it only slightly cheaper than the S&P 500 ETF.
In contrast to the broad market index, which includes fast-growing companies Nvidiathe Consumer Staples ETF consists of slower growing companies such as Procter & Gamble, CostcoAnd Walmartwhich form the top three holding companies.
These are great companies, but their valuations already seem high. For example, P&G trades at a price-to-earnings ratio of 28; Costco is fully valued at 54, and Walmart trades at a price-to-earnings ratio of 41.
Based on these valuations, investors should wait for lower entry points for these stocks, which are such a large part of the Consumer Staples ETF. Meanwhile, the Vanguard Financials ETF is the better choice here.
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American Express is an advertising partner of The Ascent, a Motley Fool company. Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Berkshire Hathaway, Costco Wholesale, Mastercard, Nvidia, Progressive, S&P Global, Vanguard S&P 500 ETF, Visa, and Walmart. The Motley Fool recommends the following options: long January 2025 $370 calls on Mastercard and short January 2025 $380 calls on Mastercard. The Motley Fool has a disclosure policy.
1 Vanguard ETF to Buy Now, 1 to Avoid was originally published by The Motley Fool
