Investing in the Vanguard S&P 500 ETF (NYSEMKT:VOO) is a smart way to guarantee your fair share of stock market returns.
The exchange-traded fund’s (ETF) low expense ratio, strong track record of closely monitoring S&P500 index and simplicity make it attractive to both new investors and seasoned veterans. Even Warren Buffett has some money in the index fund.
However, many investors might consider diversifying beyond the S&P 500. The index is currently heavily concentrated in the stocks of just a few companies. Microsoft, NvidiaAnd Apple at the time of writing, account for more than 20% of the value of the index.
If you’re looking to add more diversification to your portfolio, there are three ETFs that could be better options than continuing to buy the Vanguard S&P 500 ETF.
1. Invesco S&P 500 Equal Weight ETF
The S&P 500 is full of some of the most important companies in the world. But if you invest in a regular index fund like the Vanguard S&P 500 ETF, you’ll end up largely owning the biggest of the big ones. One way to correct that imbalance is to buy an equal-weight S&P 500 index fund, such as the S&P 500 Index Fund Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP).
This Invesco ETF invests its assets equally across all components of the S&P 500. The balance sheet is rebalanced once a quarter, so the weightings never diverge too far from each other. So even if Nvidia stock soars 50% higher in a quarter, the fund manager will sell some of it at the end of each quarter and reinvest the profits in underperforming stocks.
The equal-weighted index has historically outperformed the capitalization-weighted index. That hasn’t been the case over the past decade, as the performance of mega-cap stocks has outpaced overall market returns. But in the long run, equal weighting benefits from more investments in a wide range of companies.
The Invesco S&P 500 Equal Weight ETF will cost investors slightly more than the Vanguard S&P 500 ETF. The expense ratio is 0.2%. Still, it’s a cheap way to increase exposure to the other 497 companies in the S&P 500 that aren’t Microsoft, Nvidia, or Apple. And despite the fund buying and selling shares every quarter, the fund has never returned any capital gains to shareholders.
2. Vanguard Russell 2000 ETF
Although the S&P 500 is often used as a barometer for the overall market, the overall stock market is much larger than the approximately 500 companies that make up the index. There are more than 3,000 stocks available on the market.
You can invest in the entire stock market by purchasing a total market index fund such as the Vanguard Total Stock Market ETF. But that index fund suffers from the same weighting problems as the S&P 500 ETF. Furthermore, the expected returns of the two are virtually the same.
Instead, investing in a small-cap index fund can give you more exposure to the market than just the 500 largest companies. A separate small-cap fund allows you to specify how much you invest in smaller companies relative to your overall portfolio.
The Vanguard Russell 2000 ETF (NASDAQ: VTWO) tracks the small-cap Russell 2000 index, which outperformed the S&P 500 for 35 years from its inception in 1979 through 2014. However, since 2014, large caps have dominated the market and outperformed small caps.
But there are several indications that small caps could be poised for a comeback. The Vanguard Russell 2000 ETF provides low-cost exposure to the index with an expense ratio of just 0.1%.
3. Avantis US Small Cap Value ETF
Small-cap stocks have historically outperformed larger companies over the long term, and small-cap value stocks have done even better.
Focusing on small-cap value stocks means you’re looking at small, but often profitable, companies. These companies are more likely to survive an economic downturn, and they are less sensitive to interest rate fluctuations because they are not as dependent on debt.
While small growth stocks could be a home run, they will likely be a strikeout for investors. Small-cap value stocks consistently outperform as a group.
One of the best ETFs for small value investors is the Avantis American Small Cap Value ETF (NYSEMKT: AVUV). While it is technically an actively managed fund, it behaves more like a passive index fund. The managers set stock selection and weighting criteria based on profitability and valuation metrics, and invest in a diversified portfolio of 761 stocks. It aims to outperform the Russell 2000 value index.
With an expense ratio of just 0.25%, it’s not too expensive, even compared to fully passive small-cap value funds. And the management team has a strong track record of performance coming from Dimensional Fund Advisors.
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Adam Levy holds positions in American Century ETF Trust-Avantis Us Small Cap Value ETF, Apple and Microsoft. The Motley Fool holds positions in and recommends Apple, Microsoft, Nvidia, Vanguard Index Funds-Vanguard Total Stock Market ETF, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
Before you buy the Vanguard S&P 500 ETF, here are three others I would buy first. originally published by The Motley Fool
