It’s not easy to beat the market. Only 8% of active large-cap fund managers have outperformed S&P500 over the past 15 years. Those who simply invested in an S&P 500 index fund therefore beat 92% of professional money managers.
If you want to invest successfully, one of your best options is to stick with the S&P 500. But what if you want even more growth? The Vanguard Small-Cap ETF (NYSEMKT: VB) could be your best choice.
Always try to minimize this one thing
When it comes to investing in exchange-traded funds (ETFs), there is one thing you should try to minimize: the expense ratio. This is what the fund will charge you annually if you invest in it.
Expense ratios vary widely. Some will charge you 1% to 2% per year, while others will charge as little as 0.01%. Losing 1% or 2% of your wealth each year in fees will put a huge dent in your returns, compared to if you kept 99.9% of your money from year to year.
Costs are one of the main reasons why most professionally managed funds underperform the market over the long term. As index fund guru Jack Bogle once said, “Investors as a group need to do that underachieving the market, because the costs of participation – largely operating costs, advisory costs and portfolio transaction costs – are a direct deduction from the return of the market.
Bogle founded The Vanguard Group in 1975 to help ordinary investors avoid the high fees charged by other managers. Today, the company’s ETFs are among the most cost-effective options available. And one in particular – the Vanguard Small-Cap ETF – has outperformed the S&P 500 for decades, even after accounting for fees.
This ETF can outperform the S&P 500
The S&P 500 is a large-cap index. The portfolio consists of the 500 largest publicly traded companies in the US. The index therefore does not include small-cap companies, which historically surpassed shares with larger capitalization.
In general, small-cap stocks have shown more volatility than large-cap stocks over the past few decades. The reason makes sense: As smaller companies, these companies have less scale, less access to capital and are generally less proven. However, this increased volatility has produced above-average profits for investors willing to take the extra risk.
According to Wellington Management, over a ten-year investment period, small caps have beaten large caps two-thirds of the time. Since 1927, this outperformance would have added 2.87% of annual return to an investor’s portfolio.
One of the best ways to invest in small-cap stocks is through the Vanguard Small-Cap ETF. The fund tracks the CRSP US Small Cap Index, which includes 1,417 small-cap stocks. The expense ratio is only 0.05%, compared to an average of 0.99% for comparable funds.
There’s one problem, though: lately, so have small caps underperformed large hoods. This is a rare occurrence. For example, from 2005 to 2020, the Vanguard Small-Cap ETF beat the S&P 500 by several percentage points.
However, since then it has lagged the market by a whopping 38%. This gap between small caps and large caps is the largest since the dotcom bubble. “On a forward price-to-earnings ratio, small caps trade at 14x, versus large caps at 20x – a 30% discount,” says Wellington Management.
There’s no secret to beating the S&P 500: small caps have a long history of doing so. If you want to beat the market over the next decade, your best option seems to be a small-cap ETF like Vanguard’s, which offers direct exposure, low fees, and a historically low valuation.
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Ryan Vanzo has no position in any of the stocks mentioned. The Motley Fool holds and recommends Vanguard Index Funds-Vanguard Small-Cap ETF. The Motley Fool has a disclosure policy.
You Can Outperform the S&P 500: Buy This ETF Instead was originally published by The Motley Fool
