Is Vanguard Russell 2000 ETF a Millionaire Maker?

Most of the stock market's performance in recent years has been driven by large companies -- and it isn't just the megacap tech stocks collectively referred to as the "Magnificent Seven." Meanwhile, small-cap stocks have fallen behind.

In fact, small-cap stocks have collectively underperformed the S&P 500 by 55 percentage points over the past five years, and by 125 percentage points over the past decade. The last time small-caps traded at this much of a valuation discount relative to large caps on a price-to-book value basis was the late 1990s.

However, there's a good reason to believe the gap between small caps and large caps will narrow in the next few years. That's why the Vanguard Russell 2000 ETF (NASDAQ: VTWO) could be worth a closer look right now. Not only could the index fund outperform over the next few years, but it could be an excellent entry point for long-term investors looking to build wealth.

The Vanguard Russell 2000 ETF

The Russell 2000 is widely considered to be the top index of small-cap stocks. It consists of 2,000 components. The stocks in the Russell 2000 have a median market cap of $3.1 billion, and while it is a weighted index, no single stock makes up more than 0.41% of it.

The Vanguard Russell 2000 ETF tracks this benchmark small-cap index , and it does so for a minimal cost. The fund has an expense ratio of just 0.10%, meaning that for every $1,000 you have in the fund, only $1 will go toward fees. (Note: This isn't something you actually have to pay -- it will be reflected in the performance of your shares.)

Why now could be a great time to buy

I mentioned the valuation gap between small-cap and large-cap stocks, so let's give some numbers to illustrate that. Note that all of these metrics refer to the average of the stocks in the index.

Data source: Vanguard. All metrics as of 7/31/2024.

So, small-cap stocks as a group are trading for a significantly lower P/E multiple than large caps and for less than half the price-to-book valuation.

However, the Federal Reserve is widely expected to start lowering benchmark interest rates in September, and to continue to lower them for the foreseeable future. A falling-rate environment could be a positive catalyst for small-cap stocks in particular, and for a couple reasons:

• Smaller companies are more likely to use leverage compared with large caps, and falling rates mean cheaper borrowing costs.
• Smaller companies tend to be the beneficiary of money flowing back into stocks as the yields on risk-free assets decline and investors rotate money into riskier assets that could produce market-beating returns.

What about the long term?

While I believe the Russell 2000 is likely to deliver outsize returns for the next few years, I'm not just suggesting this as a short-term investment. In fact, since its 2010 inception, the Vanguard Russell 2000 ETF has delivered 10.7% annualized returns. If you were to achieve this level of return over a 30-year period, it would turn $10,000 into more than $211,000. If you invest, add to your investment regularly, and hold on for a long period, the Vanguard Russell 2000 ETF could indeed be a millionaire maker.

Matt Frankel has positions in Vanguard Russell 2000 ETF. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .