One of the key pillars of investing is diversification. The phrase "don't put all your eggs in one basket" applies to many things in life, and it's especially true for investing. You don't want your portfolio's success (or lack thereof) to depend on just a handful of companies.
To have a truly diversified portfolio, you need to invest in companies of different sizes, sectors, and growth potentials. Accomplishing this by investing in only individual companies can be tough because of the time and research it takes.
Luckily, there's a solution to that problem: exchange-traded funds (ETFs). ETFs are funds that contain numerous different investments within them. Instead of having to invest in a bunch of different companies, you can invest in an ETF and instantly get access to the companies within it.
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Here are two no-brainer ETFs to own in 2023 and beyond.
Vanguard S&P 500 ETF
The stock market has three major indexes: S&P 500, Nasdaq Composite, and Dow Jones. Of those, the S&P 500 is by far the most followed and popular, and for good reason. The S&P 500 tracks the largest 500 public U.S. companies by market cap, and its performance is often used interchangeably with the "stock market's performance."
The S&P 500 is a single index, but different financial companies put together their own S&P 500 ETFs. Since they all follow the same index, the only tangible difference between them is the expense ratio, which is what investors have to pay over the course of a year to cover the costs that the fund incurs investing on its shareholders' behalf. That's why the Vanguard S&P 500 ETF (VOO -0.69%) is a good choice at 0.03%. For perspective, the SPDR S&P 500 ETF Trust (SPY -0.69%) is more than 3 times more expensive at 0.0945%.
Although it only contains large-cap companies, the Vanguard S&P 500 ETF provides instant diversification, covering every major sector:
- Communication services (7.3%)
- Consumer discretionary (9.8%)
- Consumer staples (7.2%)
- Energy (5.2%)
- Financials (11.6%)
- Healthcare (15.8%)
- Industrials (8.7%)
- Information technology (25.8%)
- Materials (2.7%)
- Real estate (2.7%)
- Utilities (3.2%)
Diversification is always important, but it can be extra handy during down periods in the stock market. Being concentrated in one sector can pay off during good times (like energy in 2022, for example), but the downside during down periods typically overrides the benefit.
Even if the bear market continues, if time is on your side and you're focused on the long term, now can be a chance to invest in the S&P 500 at prices we haven't seen since early 2021. The S&P 500 has historically had negative years about a quarter of the time, but it's also historically returned around 10% annually over the long run.
Vanguard Russell 2000 ETF
Just as the S&P 500 is the go-to benchmark for large-cap stocks, the Russell 2000, which tracks the smallest 2,000 companies in the Russell 3000 index, is the go-to benchmark for small-cap stocks. A small-cap company has a market cap of between $300 million and $2 billion, and it often comes with both high risk and high reward potential.
Since smaller companies generally have fewer resources and less capital, they're often more volatile and susceptible to broader economic conditions than larger companies. That's part of the reason they often take more of a hit during bear markets. Conversely, their small size gives them much more room for growth, which can translate to big gains for investors.
Since small-cap stocks are riskier by nature, I would lean on an ETF like the Vanguard Russell 2000 ETF (VTWO 0.23%) because of its low cost (0.10% expense ratio) and diversification. The Vanguard Russell 2000 ETF contains more than 1,960 companies and also covers all 11 major sectors:
- Basic materials (4.1%)
- Consumer discretionary (12.4%)
- Consumer staples (3.3%)
- Energy (7.1%)
- Financials (17.1%)
- Healthcare (16.5%)
- Industrials (16.9%)
- Real estate (6.5%)
- Technology (10.5%)
- Telecommunications (1.7%)
- Utilities (3.9%)
Because investors flock to larger companies for stability during bear markets, small-cap stocks often get the short end of the stick during those times. But brighter days usually follow. During bull runs, prices typically increase faster than they drop during bear markets because investors rush to put money in the stock market, which can work in favor of small-cap stocks.
You don't want a large chunk of your portfolio in small-cap stocks because of the risk, but it's helpful to take some exposure to give yourself a chance at the gains that can come from them. An ETF like the Vanguard Russell 2000 ETF can serve as the foundation for your portfolio's small-cap stocks.
Stefon Walters has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
