I admit it’s attractive to cherry-pick companies to invest in now with the steep market correction.
But investing in just one company for the foreseeable future is extremely risky in my opinion. While the business can be great, a small mishap from the firm could wipe out an entire portfolio.
Therefore, given the risk of concentrating my portfolio on a single stock, I’m going to diversify my portfolio in an instant with a single investment.
And that investment would be buying an exchange-traded fund (ETF) that tracks the Standard & Poor’s 500 index, more commonly known as the S&P 500 index.
There are plenty of ETFs available that closely track the index’s return, but my pick would be the Vanguard S&P 500 ETF (NYSE: VOO).
Why Is the S&P 500 Index Attractive Now?
For those who may not know, the S&P 500 index consists of around 500 large-cap US companies in leading industries. Such companies include iPhone purveyor Apple (NASDAQ: AAPL), computer software maker Microsoft (NASDAQ: MSFT), and e-commerce retailer Amazon.com (NASDAQ: AMZN).
The S&P 500 index is generally seen as one of the best representations of the stock market as a whole. According to Investopedia, the index has returned a historic annualised average return of around 10.5% from its inception in 1957 to 2021.
To be part of the S&P 500 index, a company must meet some of the following criteria :
- It must be a US company;
- The market capitalisation must be US$14.6 billion or higher;
- It must have positive as-reported earnings in its most recent quarter, and over the most recent four quarters summed up; and
- The stock must have adequate liquidity and must trade for a reasonable share price.
The strict entry criteria form a barrier and ensure that investors are getting to invest in some of the best companies out there with relatively low effort.
The S&P 500 is in negative territory, having fallen 12% from a peak of 4,796.56 seen on 3 January 2022. Only last month, it was in bear market mode with a fall of 20%.
A fall of over 10% may sound terrifying, but therein lies the opportunity, if we have a long-term focus.
(Fun fact: A 10% fall in the stock market is a common occurrence.)
Over the short term, anything can happen to the US stock market, but over the long run, history has shown that stocks tend to rise.
During the depths of the Great Financial Crisis (GFC) back in October 2008, famed investor Warren Buffett explained the need to look at the long term in an op-ed for The New York Times entitled, Buy American. I Am. (emphasis is mine):
“Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
Since that op-ed, the S&P 500 index has gone on to rise over 300% to close at 4,210.24 on 10 August 2022. Those who had invested during the GFC would be sitting on juicy returns over the past 13 years or so.
Right now, people are fearful that the inflationary and rising interest rate environment could trigger a recession.
While a recession may happen and stocks could continue languishing before recovering, we should remember that this is not new and that humanity has survived several market crashes previously.
So, “this too shall pass”.
And once the storm is over, stocks should continue climbing higher, as history has shown time and again.
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Why Vanguard S&P 500 ETF?
I’m choosing the Vanguard S&P 500 ETF to invest in since it has the lowest expense ratio among the S&P 500 ETFs of 0.03%.
The SPDR S&P 500 ETF (NYSE: SPY), which was the very first ETF listed in the US and is the more popular option, has a higher expense ratio of 0.0945%. An ETF’s expense ratio reveals how much investors are paying as fees annually when investing in the ETF.
Bringing down expenses when investing is essential since a fund with high costs will eat into our returns.
Another attractive aspect of the Vanguard S&P 500 ETF is that it allows instant diversification with a single click of the button.
To understand how diversified the ETF is, let’s take a look at the following snapshot showing the fund’s sector composition:
Based on the Global Industry Classification Standard (GICS) sector classification, information technology (at 27.1%) contributes to the bulk of the ETF, followed by healthcare (14.4%), and financials (11.2%).
In terms of specific companies, Apple takes up 6.5% of the pie, followed by Microsoft, and Amazon. The top 10 companies occupy around 26% of the fund.
Now could be a good time to start investing in the Vanguard S&P 500 ETF. According to JP Morgan’s Guide to the Markets (3Q 2022) , the index is selling at a forward price-to-earnings (P/E) ratio of 15.9x, as of 30 June 2022. For the past 32 years, the S&P 500 index’s forward P/E ratio stood at an average of 16.2x. This suggests that the index is fairly valued right now. If its valuation comes down further, investors have the chance to dollar-cost average (DCA) into the ETF, diversifying across time as well.
The Power of Compounding
Since Vanguard S&P 500 ETF’s inception in 2010, the fund has produced an annualised return of 13%.
US$100,000 invested in the Vanguard S&P 500 ETF some 12 years ago would have turned into almost half a million dollars by now. That’s the power of compounding taking effect.
Warren Buffett said in his 2016 Berkshire Hathaway shareholder letter that “investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.”
That’s what I’ll be doing by buying a low-cost fund with Vanguard S&P 500 ETF and sitting on it for the long run to allow the magic of compounding to occur. To add icing to the cake, my overall return could be higher than average as I’ll be investing during a bear market.
Knowing Your Downside
All investments come with risks, and investing in the Vanguard S&P 500 ETF is no exception.
One risk is to do with foreign exchange. Since this ETF is denominated in US dollars, any adverse fluctuations against the US dollars for a Singapore investor could harm the overall returns.
The volatile market condition is something else to take note of.
Stocks in general are subject to wide movements in share price in the short term. That’s what we are experiencing currently. As we discussed earlier, stocks could fall further before they recover, depending on how the economic conditions plays out.
Having said that, we should also understand that volatility is part and parcel of investing in the stock market, and it’s not a bug in the system.
If one is willing to stomach the short-term volatility and stay the course after investing in the ETF, the investor should reap the rewards over the long run.
As author and investor Morgan Housel once mentioned:
“Volatility is the price of admission. The prize inside are superior long-term returns. You have to pay the price to get the returns.”
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Disclaimer: This information provided in this article is purely based on my opinions and is not intended to be personalised investment advice. The ideas discussed here are not recommendations to buy/sell any stock.
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