The S&P 500 index is currently trading near its all-time highs. This means that exchange-traded funds (ETFs) tracking this index, such as the Vanguard S&P 500 Index ETF (VOO), are also at elevated levels. While investing in the S&P 500 remains a sound strategy, especially for new investors, a closer look at market valuations suggests an alternative approach might offer a smarter choice: considering value-focused ETFs.
Key Takeaways
- The S&P 500 and its tracking ETFs are near record highs.
- Starting investment early is crucial, even with $1,000.
- Vanguard S&P 500 ETF (VOO) offers low-cost market exposure.
- Vanguard Value ETF (VTV) presents a potentially smarter option due to lower valuations.
- Combining S&P 500 and Value ETFs can offer diversification.
Starting Your Investment Journey
One of the most important steps any individual can take in their financial life is to begin investing. For those with $1,000, or any amount, and no prior investment experience, simply buying into the broader market is often recommended. The S&P 500 index serves as the market benchmark for most U.S. investors.
Establishing a routine of monthly investments into the market can benefit from a strategy known as dollar-cost averaging. This involves investing a fixed amount regularly, regardless of market fluctuations. This approach helps reduce the risk of investing a large sum at a market peak.
"If you have $1,000 or $10,000 (or even more) to invest, just getting started is going to be the smartest move. Then, keep going and never look back."
Fact: Low-Cost Index Funds
The Vanguard S&P 500 ETF (VOO) is a popular choice for S&P 500 exposure due to its extremely low expense ratio of 0.03%. This makes it one of the most cost-effective ways to track the performance of the S&P 500 index.
Understanding Market Cycles and Valuations
Historical data shows that the stock market has consistently recovered from downturns, even severe bear markets, to reach new highs over time. This long-term trend supports the strategy of consistent investment.
However, when the market is at or near all-time highs, some investors may feel hesitant. This is where considering valuations becomes important. Valuations measure how expensive a stock or an index is relative to its earnings, book value, or other financial metrics.
The Case for Value Investing
While the S&P 500 offers broad market exposure, another option, the Vanguard Value ETF (VTV), focuses on companies with lower valuations. This ETF invests in large U.S. companies that are considered undervalued compared to the broader market.
This approach can be particularly appealing when the overall market, including the S&P 500, is trading at elevated valuation multiples.
Market Context: Price-to-Earnings Ratio
The price-to-earnings (P/E) ratio is a common metric used to assess a company's or an index's valuation. A higher P/E ratio generally indicates that investors are paying more for each dollar of earnings, suggesting a higher valuation.
Comparing ETF Valuations
To illustrate the difference in valuations, let's look at average P/E ratios for different Vanguard ETFs:
- Vanguard Growth ETF (VUG): This ETF, which invests in growth-focused companies, has an average P/E ratio of approximately 40. This higher ratio is typical for growth stocks, as investors expect future earnings growth.
- Vanguard S&P 500 Index ETF (VOO): The S&P 500 ETF has an average P/E ratio of about 29. This is still considered relatively high, partly driven by the strong performance and higher valuations of large technology companies within the index.
- Vanguard Value ETF (VTV): In contrast, the Vanguard Value ETF has an average P/E ratio of just under 21. While not necessarily "cheap," this valuation is significantly lower than both the S&P 500 and the Growth ETF.
Price-to-Book Value Comparison
Another key valuation metric is the price-to-book (P/B) ratio. This compares a company's market price to its book value per share.
- Vanguard Growth ETF (VUG) shows a P/B ratio of 12.5.
- Vanguard S&P 500 Index ETF (VOO) has a P/B ratio of 5.2.
- Vanguard Value ETF (VTV) stands at the lowest with a P/B ratio of just 2.8.
These figures indicate that value stocks, as represented by VTV, are trading at lower multiples relative to their assets compared to growth stocks and the broader S&P 500.
Strategic Investment Approaches
The most crucial investment decision is to begin investing. The second is to maintain consistent investments, even during challenging market periods. However, once these fundamental steps are in place, a more nuanced approach might be beneficial.
If an investor is starting with $1,000, they could consider splitting their investment between the S&P 500 Index ETF and the Value ETF. This strategy would provide exposure to the overall market while also leaning towards stocks with potentially lower valuations.
Why Diversify with Value?
Focusing on value stocks when growth stocks are leading the market may help soften the impact of a significant market downturn. While it does not guarantee protection from a bear market, it can provide a measure of diversification away from highly valued growth sectors.
For investors who already have an established portfolio, adding funds to a Value ETF could serve as a diversification strategy. This helps balance a portfolio that might be heavily weighted towards growth stocks, which have driven much of the recent market gains.
Ultimately, making informed choices about where to allocate capital, especially when market valuations are high, can contribute to a more resilient and balanced investment portfolio over the long term.
