Buy 2 Index Funds to Beat the IS&P 500 Over the Next 5 Years, According to Wall Street Analysts
In April, State Street revised its long-term asset class forecasts. I S&P 500 (SNPINDEX: ^GSPC) is expected to return 7.1% annually over the next three to five years, while S&P Small Cap 600 again MSCI Emerging Markets the indexes are expected to return 7.6% and 7.5% annually, respectively.
Investors can gain exposure to those indices by purchasing shares of Vanguard S&P Small-Cap 600 ETF (NYSEMKT: VIOO) as well as iShares MSCI Emerging Markets ETF (NYSEMKT: EEM). Here are the important details.
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Vanguard S&P Small-Cap 600 ETF
The Vanguard S&P Small-Cap 600 ETF tracks 600 US companies that meet the definition of a small-cap stock, which currently includes stocks with market capitalizations from $1.2 billion to $8 billion. The index fund holds stocks from all 11 market sectors, but its holdings are concentrated in financials (18%), industrials (17%), consumer discretionary (13%), and technology (12%).
The five largest positions in the Vanguard S&P Small-Cap 600 ETF are as follows.
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Eastman Chemical: 0.5%
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Element solutions: 0.5%
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Primoris Services: 0.5%
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Viavi Solutions: 0.5%
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Argan: 0.4%
The Vanguard S&P Small-Cap 600 ETF has returned 180% (10.8% annually) over the past decade, while the S&P 500 has posted a total return of 315% (15.2% annually). Another reason small stocks underperformed during that period was high interest rates, which often have a disproportionate impact on small businesses because they rely heavily on floating rate debt.
The Vanguard S&P Small-Cap 600 ETF has a reasonable expense ratio of 0.07%, meaning shareholders will pay $7 a year over every $10,000 invested. While that’s well below the average for US index funds, it’s still more expensive than the average expense ratio of 0.03% Vanguard S&P 500 ETF.
iShares MSCI Emerging Markets ETF
The iShares MSCI Emerging Markets ETF tracks approximately 1,225 companies across emerging economies. It is mainly represented in China, Taiwan, South Korea, and India, but also includes stocks from Brazil, South Africa, and Saudi Arabia. The fund has a large percentage of its assets invested in three sectors: technology (32%), financials (21%), and consumer discretionary (10%).
The five largest holdings in the iShares MSCI Emerging Markets ETF are as follows.
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Taiwan Semiconductor: 14.1%
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Samsung Electronics: 6%
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SK Hynix: 4%
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Tencent: 3.2%
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Alibaba Group: 2.3%
The iShares MSCI Emerging Markets ETF has returned 133% (8.8% annually) over the past decade, while the S&P 500 has posted a total return of 315% (15.2% annually). The main reason that US stocks performed so well at that time was the dominance of US technology stocks, especially the “Magnificent Seven” stocks.
The iShares MSCI Emerging Markets ETF has a top expense ratio of 0.72%, meaning investors will pay $72 a year for every $10,000 invested in the fund.
Why investors should still prioritize the S&P 500 index fund (or major US stocks)
State Street believes that small US stocks will outperform the S&P 500 (large US stocks) in the next three to five years due to cheap valuations and strong earnings growth. Indeed, income in 2026 is predicted to grow faster than income for the first time in years, according to the report. FactSet research.
However, companies with less capital are also more vulnerable to higher interest payments, and the war in Iran has made interest rate cuts less likely. Investors entered the year expecting the Federal Reserve to cut rates by at least 50 basis points, so the Vanguard S&P Small-Cap 600 ETF doubled the return of the S&P 500 through 2026. But if the rate cuts fail to materialize, that outperformance could be reversed.
Meanwhile, State Street also believes that emerging market equities will outperform the S&P 500 over the next three to five years due to a weaker U.S. dollar (which increases the returns on foreign currency investments when converted back to the U.S. currency), strong earnings growth, and relatively cheap equities.
However, most of the largest technology companies reside in the US, which means that the US economy is best positioned to benefit from the artificial intelligence revolution. In turn, US stocks (especially large stocks in the S&P 500) may continue to outperform emerging market equities in the coming years.
Here’s the bottom line: I think State Street makes good arguments for owning small and emerging market funds, but I’d still prioritize the S&P 500 index fund (or major US stocks) over those options. The S&P 500 provides exposure to the world’s most impactful companies, making it a compelling long-term investment.
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Trevor Jennewine has positions in the Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends FactSet Research Systems, Taiwan Semiconductor Manufacturing, Tencent, Vanguard S&P 500 ETF, and Viavi Solutions. The Motley Fool recommends Alibaba Group. The Motley Fool has a policy of disclosure.
Buy 2 Index Funds to Beat the IS&P 500 Over the Next 5 Years, According to Wall Street Analysts was originally published by The Motley Fool.
