A great way to create wealth over the long term is through investing. But it isn’t necessarily an easy way, especially for beginners. For those just starting out, finding the right individual stocks to invest in can seem a bit overwhelming.
J.P. Morgan‘s investment firm published a study in 2021 that found that 40% of companies in the Russell 3000 index, which tracks the 3,000 largest stocks traded in the U.S., saw a catastrophic price loss between 1980 and 2020. It defined this as a loss of 70% or more from which the stocks never recovered to hit new highs. Meanwhile, over 40% of stocks saw negative returns during this period, and two-thirds of stocks underperformed the index. That’s a lot of stocks that didn’t do well at all.
While plenty of individual stocks underperformed, stock market indexes such as the S&P 500 have produced tremendous returns over time. The S&P managed to generate an average annual return of 13% over the past decade (as of the end of August 2024), or nearly 239% on a cumulative basis.
How can the S&P 500 perform so well when so many individual stocks struggle?
The answer has to do with how the index is compiled and maintained. The S&P 500 is market-cap weighted, meaning it lets its winners run and become a bigger percentage of its holdings, while its losers become smaller until they eventually drop out.
The approximately 10% of companies called megawinners in the J.P. Morgan study are the ones that power the overall market. These megawinners are stocks that outperformed the Russell 3000 by 500% or more during the period studied.
So where should new investors put their money?
So the S&P 500 is designed to outperform that overall market. It’s this fact that leads most pundits to advise new investors to start investing in an exchange-traded fund (ETF) that tracks the S&P 500. After all, it’s a large and popular index with a history of solid returns.
But I’m not like most pundits and I think there is an even better ETF that new investors should focus on: the Vanguard Growth ETF (NYSEMKT: VUG). This ETF tracks only the S&P 500 index constituents that qualify as growth companies (roughly half of them). The ETF has nicely outperformed the S&P 500 index over the years, with a 15.1% average annual return over the past 10 years. While that may not sound much more than the 13% return of the S&P, on a cumulative basis it equals a nearly 307% return (compared to 239%).
An investment of $10,000 in this growth ETF a decade ago would be worth nearly $40,700 today. That same investment in an ETF that tracks the full S&P 500, such as the Vanguard S&P 500 ETF (NYSEMKT: VOO), would be worth about $33,750. That’s a significant difference.
The Vanguard Growth ETF is the better option because of the JP Morgan notion of megawinners powering the market. When you look at the largest companies trading in the U.S., most are classified as growth stocks. The only companies not classified as growth companies among the S&P 500’s top 10 holdings are Berkshire Hathaway and (oddly) Broadcom.
But it is growth companies such as Apple, Nvidia, Microsoft, and Amazon that have grown to become the largest companies in the world by increasing their revenues and profits at fast clips. And many of the top holdings on the value side of the S&P were previously in the growth category, such as Walmart and Home Depot, that have just matured.
S&P 500 ETFs do give investors exposure to potential megawinners, but the Vanguard Growth ETF offers a bit more exposure to these stocks, leading to outperformance over time.
For that reason, I think the Vanguard Growth ETF is great place for new investors to begin their investing journeys. By using a dollar-cost average strategy of putting money into the index with each paycheck or each month, new investors can create a lot of wealth in the years to come.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Apple, Berkshire Hathaway, Home Depot, JPMorgan Chase, Microsoft, Nvidia, Vanguard Index Funds-Vanguard Growth ETF, Vanguard S&P 500 ETF, and Walmart. The Motley Fool recommends Broadcom and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
How Should a Beginner Invest in Stocks? Start With This ETF. was originally published by The Motley Fool