If you’re like most investors, your ultimate investment goal is to secure the best possible retirement. Most people also understand that achieving this goal requires assuming the risks inherent in owning stocks. Bonds, real estate and commodities are certainly capable of producing positive returns. However, they usually can’t outrun inflation in the long run, whereas stocks can – and do. Even a long-term investment in a simple index fund like the SPDR S&P 500 ETF Trust (NYSEMKT: SPY) does the trick, only requiring someone to buy it and keep it for years.
And if, however, a S&P500– Wasn’t an index fund your only viable indexing option, or even your most profitable prospect?
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It turns out that’s not the case. There’s a distinctly different exchange-traded fund you might want to consider first. It’s the iShares Core S&P Mid-Cap ETF (NYSEMKT:IJH).
Better yields for all the right reasons
As its name suggests, the iShares S&P Mid-Cap ETF is a basket of stocks reflecting the mid-cap stocks in the market. Namely, it is meant to mirror the S&P 400 Index, which consists of 400 different tickers that are not yet large enough to be considered large caps, but too large to be considered small caps. Although not a hard and fast rule, mid-cap companies typically have market capitalizations between $2 billion and $10 billion.
It turns out to be something of a high-growth sweet spot for startups that are on their way to becoming much bigger powerhouses. They are past their wobbly early years where capital can be difficult to attract, but not yet to the point in their lives where their products and services can reliably generate profits time and time again. For many organizations, the mid-cap years are also a key turning point – for the better – for their underlying businesses.
The proof of this idea lies in their long-term returns. While the SPDR S&P 500 ETF Trust has gained 337% over the past 20 years, the iShares Core S&P Mid-Cap ETF has fared much better, rising 457% over the same two-year period. decades.
Few current components of the S&P 400 were part of the index then. They went to large cap status, ended up collapsing, got acquired, got taken private, or saw some other scenario unfold.
That’s not a bad thing, however. Indeed, it is a good thing for investors. Continuously replacing stocks that meet a certain set of criteria ensures that stocks in an index always deliver exactly what they are supposed to. In this case, it’s companies that ignore their start-up difficulties en route to self-sustaining results.
While mid-caps in general (and mid-cap funds in particular) pack more firepower than typical large-cap or large-cap ETFs, that doesn’t change how investors should manage them. The S&P 400 Mid-Cap Index remains an index. Like its large-cap counterpart, the point of owning such a fund is to buy and hold a basket of certain types of stocks over the long term, rather than going back and forth.
That said, there may be a strategic difference between buying a fund like the SPDR S&P 500 ETF Trust and buying the iShares Core S&P Mid-Cap ETF. In other words, while limiting your index holdings to those based on the S&P 500 is not a mistake, even if you limit your index position to large caps, you may not want to impose the same type of limitation when you are a fan. of the idea of mid-caps.
While they clearly generate better long-term returns, they are also more volatile, making them harder to stick to at times. A savvy way to reduce some of this stress-inducing volatility is to spread your index holdings evenly between SPY and IJH. This will reduce your overall earnings potential, but given the historically stronger mid-cap earnings, you are still likely to achieve above-market returns with the exposure.
10 stocks we prefer to the iShares S&P MidCap 400 Index
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.