You Can Do Better Than the S&P 500. Buy This ETF Instead. | The Motley Fool (2024)

When talking about the stock market, investors view the S&P 500 as the key barometer for gauging how things are going. Because this index tracks the 500 largest and most profitable businesses in the U.S., the world's most dominant economy, investors closely watch its price movements.

Historically, the S&P 500 has been a superb investment, enough so that even Warren Buffett recommends most people put money into an index fund that follows it. In the last 20 years, including dividends, the broad market index has returned roughly 10.2% per year, which would turn a $10,000 initial investment into $69,200.

There's no denying how wonderful that type of gain is. But some investors surely want to see even greater returns. You can certainly do better than the S&P 500. You just have to consider buying this exchange-traded fund (ETF) instead.

Focusing on growth businesses

In the trailing five-, 10-, 15-, and 20-year periods, the Vanguard Growth ETF (VUG 0.01%) has outperformed the S&P 500. That is a remarkable track record. And it's a long-enough time horizon to have confidence that this streak can continue in the years ahead. That same $10,000 initial investment in this ETF over the last 20-year time frame would result in an ending value of over $88,430.

The Vanguard Growth ETF contains 208 different stocks. Compared to the average businesses out there, these companies typically report faster top- and bottom-line growth. Over the last five years, the average enterprise in this fund saw its earnings rise at a superb 19.6% per year.

But investors have to pay up for this type of performance. The average price-to-earnings (P/E) ratio in the Vanguard Growth ETF is 37.3, much more expensive than the S&P's P/E multiple of 23.2.

It's important to understand the makeup of this ETF. Because growth is the primary focus and objective, it shouldn't be too much of a surprise that 55.8% of its holdings come from the technology sector, and 20% come from the consumer discretionary sector. These industries exhibit much better growth potential than sectors like financial services, utilities, or industrials, for example.

Given the heavy leaning toward the tech sector, the so-called "Magnificent Seven" businesses are prominent. Combined, Apple, Amazon, Alphabet, Microsoft, Meta Platforms, Tesla, and Nvidia make up a whopping 52% of the entire Vanguard Growth ETF. These stocks have soared in the past several years.

Some risk-averse investors might not be comfortable owning these kinds of companies because they operate in various industries, like e-commerce, cloud computing, digital advertising, electric vehicles, semiconductors, enterprise software, and consumer electronics, that undergo rapid change. However, having the opportunity to earn higher returns compensates for that.

Keep this in mind

Besides its constituents and past returns, investors should pay attention to other factors. Because the expense ratio of 0.04% is so low in the Vanguard Growth ETF, investors get to keep more of their returns over time. And knowing that Vanguard is a reputable firm with a nearly five-decade history and trillions of dollars under management should give you some peace of mind.

If possible, a standard best practice is to dollar-cost average. Adding savings on a regular basis can supercharge returns over time. Plus, it eliminates the need to try and time the market.

I see no reason why someone can't own both the Vanguard Growth ETF and an S&P 500 fund, as well as other investment vehicles that target other objectives, in a rounded out and well-diversified portfolio. Just remember to always maintain a long-term time horizon when investing.