New investor? Welcome to the market.
Of course, even if you’ve only been ready and able to take the plunge for a short time, you probably already realize there’s no shortage of advice out there. Most of it is well-intended, and some of it may even qualify as “good.” If any of it includes a recommendation for individual stocks as your foray into the investment arena, though, take a moment and give some serious consideration to another tip you’ve likely heard by now: to buy an index fund representing a broad slice of the market.
The index fund I’m going to recommend, however, isn’t the fund I’m sure has come so highly recommended from other sources.
A savvier choice (for most)
You may have read or heard that the SPDR S&P 500 ETF Trust (NYSEMKT: SPY) is a great way to begin your investing journey. And truth be told, if that’s the choice you end up making, you’ll indeed be off to a good start. This exchange-traded fund (ETF) encompasses about 80% of the stock market’s total value, allowing you to participate in the economy’s persistent (albeit cyclical) growth without forcing you to become a stock picker.
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But if following the crowd just isn’t your thing, you’ll likely fare even better with the iShares S&P MidCap 400 Index Fund (NYSEMKT: IJH).
Some experienced investors may be surprised at this pick as a better place to start, but there are specific reasons the mid-cap fund could be a smart choice for newcomers.
While the S&P 500 consists of companies considered large-caps, the S&P 400 MidCap Index is made up of America’s mid-sized corporations. It’s not a hard-and-fast rule, but generally speaking, these organizations sport a market capitalization between $2 billion and $10 billion. That’s big enough to ensure they’re going to be around for a while but too small to capture most investors’ (and the media’s) attention.
While S&P 500 companies make up roughly 80% of the stock market’s value and earnings, the next biggest 400 companies that make up the S&P 400 Index collectively account for between 10% and 15% of the U.S. stock market’s total value.
It’s a particularly potent sliver of the investable market, though. As Standard & Poor’s explains of its index: “Mid-cap exposure generally captures a phase in the typical corporate life cycle in which firms have successfully navigated the challenges specific to small companies, such as raising initial capital and managing early growth.” Standard & Poor’s adds, however, “At the same time, mid-caps tend to be quite dynamic and not so large that continued growth is unattainable.”
In simpler terms, many of these organizations are in something of a sweet spot for investors.
This unique edge shines through with the ETF’s long-term results. While the SPDR S&P 500 ETF Trust’s gain of nearly 300% since the beginning of this century mirrors the gain of the index it represents, the MidCap 400 Index Fund has almost doubled that performance.
Don’t get too excited just yet, however. Take a closer look at the chart. There can be months and even sometimes years when mid-caps lag large-cap stocks. These mid-sized stocks have underperformed since COVID-19 ripped across the world, for instance, creating challenges that larger companies can more easily overcome.
If you’re truly planning on being in the market for the long haul, though, these sorts of soft patches are less of a concern.
Position yourself now for the inevitable second-guessing down the road
As I noted above, a stake in the SPDR S&P 500 ETF Trust is still a sound choice. Or perhaps the smartest option is splitting the difference and owning a piece of both investments. That way you don’t have to feel like you’re missing out on either option’s unique upside.
And that’s no small matter.
Perhaps the biggest risk new investors face is the ease with which you can lose interest in a long-term holding when it feels like other options might end up performing better. With a position in mid-caps that historically outperform large-caps, however, you’re still holding a smart, risk-adjusted opportunity to do just that. This dynamic makes it at least a little less unnerving to stick with index-based investments when it’s psychologically tough to do so … like after a steep sell-off.
Factor in that mid-caps and large-caps as a group may not hit their major lows at the same time, and the temptation to try timing any trade entries and exits is even further reduced.
Whatever the case, the S&P MidCap 400 Index Fund still…