Choosing an individual stock to buy is hard -- and risky. Even when selecting from a pool of great businesses, there's a good chance that the stock you choose will underperform the market, and potentially by a wide margin.
That's an excellent reason to make exchange-traded funds (ETFs) a cornerstone of your investing strategy. These financial instruments allow you to own hundreds or thousands of stocks, delivering instant diversification with a single purchase. And you can get there without a huge cash outlay. In fact, just a few hundred dollars can get you into some great ETFs. Let's look at two of the most popular.
1. Vanguard Total Stock Market Index Fund
The Vanguard Total Stock Market Index Fund (VTI 0.09%) is hugely popular with investors, whether they're seasoned professionals or are just starting off on their financial journeys. In fact, over $1.6 trillion of assets are sitting in the ETF as of late March.
This fund tracks the performance of the CRSP Total Market index, which includes the full range of company sizes (small, medium, and large capitalization) along with all the major market sectors. You'll essentially own the entire U.S. stock market when you purchase this fund. You won't own any bonds or stocks that don't trade on U.S. exchanges, though.
Be aware that you're getting extra exposure to the tech sector, since that's where most of the market's biggest businesses compete today. The ETF's top 10 holdings include nearly all of the "Magnificent Seven," with Microsoft and Apple sitting in first and second place, respectively.
The fund is extremely cheap, carrying an expense ratio of just 0.03%. That's a direct result of its passive management approach that avoids the use of costly investment managers. Your returns will be very close to the wider market's through that strategy. Vanguard Total Stock Market has returned 81% over the past five years, or just slightly below the 88% growth in the S&P 500 in that time.
2. Vanguard Dividend Appreciation ETF
The Vanguard Dividend Appreciation ETF (VIG 0.37%) is an excellent choice for investors who want a balance between income and growth. Sure, you'll own several of the same stocks that comprise the Total Stock Market Index Fund. Microsoft and Apple are the top two holdings in this dividend ETF, too.
However, this ETF's top 10 holdings list is dominated by non-tech companies like Visa, Procter & Gamble, and Home Depot -- namely, businesses that have been paying dividends for decades. The fund prioritizes stocks that are growing their dividends rather than those that simply offer the highest yields. That means you'll get a bit less income from this ETF than with a fund like the Vanguard High Yield Dividend ETF (VYM 0.33%). But you should see that income rise quickly over time.
The Vanguard Dividend Appreciation ETF is highly efficient, with rock-bottom expenses of just 0.06%. Its yield is close to 2%, significantly higher than the 1.3% rate that you'd get from the Vanguard Total Stock Market Index Fund. Keep in mind that returns have trailed the wider market over the past year due to the rally that's been fueled mostly by growth stocks. This fund will tend to outperform, meanwhile, during market downturns.
Owning any one of this fund's top holdings individually can expose you to weak returns due to struggles in an industry like consumer staples or enterprise cloud services. Yet by purchasing the ETF instead, you eliminate that diversification risk while still positioning yourself for great long-term returns.
