One popular investing strategy is "buying the market." The way to do that is to invest in the gamut of stocks on the market, since it's very hard to beat the market. Instead of trying, it makes sense to invest in an index fund that mirrors the makeup of a broad market index like the S&P 500 and benefit from passive investing . Even investors who don't subscribe wholly to that theory have some money invested in such a fund, often in the form of an exchange-traded fund (ETF).
But what if you could invest in just the best half or so of the S&P 500? You'd still have healthy diversification, but you'd benefit from exposure to the largest and highest-growth companies in the index. Plus, if it's in the form of an ETF, you'd still get the perks of passive investing.
You can get all this and more if you invest in the Vanguard Growth ETF (NYSEMKT: VUG) , and it's likely to beat the market over the next five years and longer. Here's why.
The purpose of an index fund
The purpose of investing in any ETF is to gain exposure to a category, trend, or broad market indicator without actively choosing and monitoring a group of stocks. Every ETF has a basket of stocks. Some are quite small, with just a handful of stocks, while others have thousands of stocks.
In general, the larger the base, the lower the risk, and vice versa. ETFs that mirror the S&P 500 are quite popular, and for good reason: If you can't beat 'em, join 'em. They're a safe and effective way to grow your money over time with low risk and low expenses.
ETFs that go after a specific trend dilute the risk of any one of them failing, but there's risk in the premise of any trend not taking off or being eclipsed by something new. Artificial intelligence (AI) ETFs look attractive today because of the potential in the technology, but they could be affected by setbacks in the industry.
Why this ETF stands out
The Vanguard Growth ETF tracks the CRSP US Large Cap Growth Index . It owns about 200 of the largest and most growth-oriented stocks in the S&P 500. 200 stocks is a well-diversified basket, and although this is called a growth ETF, the stocks with the highest representation are mostly large, established companies that are low-risk. They're mostly the top 200 stocks in the S&P 500, with Apple (NASDAQ: AAPL) , Microsoft (NASDAQ: MSFT) , Nvidia (NASDAQ: NVDA) , Amazon (NASDAQ: AMZN) , and Meta Platforms (NASDAQ: META) leading the way. Eli Lilly (NYSE: LLY) and Visa (NYSE: V) are also top-10 holdings.
Since it just invests in high-growth companies, it has a greater likelihood of beating the market when those companies are doing well. But because many of these companies are well-established with proven track records, and because there are so many stocks, investors don't bear the risk of concentrated positions in just a few individual stock positions. Plus, the growth ETF has a low expense ratio of 0.04% compared to the industry average of 0.95%, so you get to keep more of your gains.
Past performance is no guarantee, but there's every reason to expect more of the same
So far, that just explains why this ETF should outperform the market. But it's been around for some time, so we can already see how it measures up.
^SPX data by YCharts.
The growth ETF outperformed the broader market by more than two full percentage points on an annualized basis over the past 10 years. That might look like a small difference, but over time with compounding , it adds up. For example, if you'd invested $10,000 in a market index fund over the past 10 years, you'd have almost $33,000 today. But if you'd invested the same amount in the Vanguard Growth ETF instead, you'd have almost $40,000.
Since the makeup and strategy of the S&P 500 and the growth ETF aren't changing, it's reasonable to expect similar results over the next five years and longer. Just remember that growth is never linear, and it doesn't mean you can expect this ETF to outperform the market every day or even every year. But over time, it may well beat the market by a comfortable margin.
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