If you’re like most investors, your ultimate investment goal is securing the best retirement possible. Most people also understand achieving this goal requires taking on the inherent risks of owning stocks. Bonds, real estate, and commodities are certainly capable of producing positive returns. They typically can’t outgrow inflation for the long haul, though, whereas stocks can — and do. Even a long-term holding 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 then hold onto it for years.
What if, however, an S&P 500-based index fund wasn’t your only viable indexing option, or even your highest-payoff prospect?
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As it turns out, it isn’t. There’s a distinctly different exchange-traded fund you may want to consider first. That’s the iShares Core S&P Mid-Cap ETF (NYSEMKT: IJH).
Better returns for all the right reasons
As the names suggests, the iShares S&P Mid-Cap ETF is a basket of stocks reflective of the market’s mid-cap stocks. Namely, it’s meant to mirror the S&P 400 index, which consists of 400 different tickers that aren’t yet big enough to be considered large caps but too big to be considered small caps. While not a hard-and-fast rule, mid-caps typically boast market capitalizations of between $2 billion and $10 billion.
As it turns out, that’s something of a high-growth sweet spot for start-ups that are en route to becoming much bigger powerhouses. They’re beyond their initial wobbly years when capital may be tough to attract, but not yet at the point in their life where their products and services can reliably generate profits over and over again. For many organizations, the mid-cap years are also a key turning point — for the better — for their underlying businesses.
Evidence of this idea lies in their long-term returns. While the SPDR S&P 500 ETF Trust has gained a hefty 337% over the course of the past 20 years, the iShares Core S&P Mid-Cap ETF has fared much better, with a 457% advance during that same two-decade stretch.
Few of the S&P 400’s current constituents were part of the index then. They’ve graduated to large-cap status, ended up falling apart, were acquired, taken private, or saw another scenario unfold.
That’s not a bad thing, though. Indeed, it’s a good thing for investors. The ongoing replacement of stocks that meet a certain set of criteria ensures that an index’s stocks always offer exactly what they’re supposed to offer. In this case, that’s companies shrugging off their start-up struggles en route to self-sustaining results.
While mid caps in general (and mid-cap funds in particular) bring more firepower to the table than the typical large cap or large-cap ETF, this changes nothing about how investors should handle them. The S&P 400 Mid-Cap Index is still an index. Like its large-cap counterpart, the whole point of owning such a fund is to buy and hold a basket of certain sorts of stocks for the long haul, rather than hopping in and out of them.
That said, there may be one strategic difference between buying a fund like the SPDR S&P 500 ETF Trust versus buying the iShares Core S&P Mid-Cap ETF. That is, while limiting your index holdings to S&P 500-based ones isn’t a mistake even though you’re limiting your index position to large caps, you may not want to impose the same sort of limitation when you’re a fan of the mid-cap idea.
Although they clearly drive better long-term returns, they’re also more volatile, making them tougher to stick with at certain times. A savvy way to curb some of this stress-inducing volatility is by evenly splitting your index holdings between SPY and IJH. That will crimp your overall bottom-line potential, but given mid caps’ historically stronger results, you’re still apt to achieve significant market-beating returns with the exposure.
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