With U.S. stocks reaching record highs, investors looking to grow their portfolios face a no-win decision: buy stocks at today’s high prices or risk missing out on even more gains. At first glance, there seem to be only bad options. Look a little deeper, however, and a third alternative emerges.
What’s the alternative? Investors can buy diversified growth index funds instead.
That’s because the recent stock market rally hasn’t hit everywhere in the world at the same time. The FTSE100, an index of U.K. companies, for instance, sits below its 1999 peak. So when it comes to buying stocks right now, it’s about knowing where to look.
Here are 7 index funds to buy for diversified growth:
- iShares MSCI China ETF (NASDAQ:MCHI)
- ProShares MSCI EAFE Dividend Growers (BATS:EFAD)
- Invesco S&P500 Equal Weight Tech ETF (NYSE:RYT)
- SPDR S&P Biotech ETF (NYSE:XBI)
- S&P Small Cap 600 Value ETF (NYSE:IJS)
- iShares MSCI Frontier 100 (NYSE:FM)
- Vanguard Total International Stock ETF (NASDAQ:VXUS)
Low stock prices worldwide, compounded with an impending coronavirus recovery, means that investors can still buy fast-growth index funds for cheap. Let’s dive in.
Index Funds To Buy For Diversified Growth: iShares MSCI China ETF (MCHI)
Chinese companies listed on U.S. exchanges have been on a tear this year. Since January, the average ADR has returned almost 80%, led by fast-growing companies like Alibaba (NYSE:BABA) and Nio (NYSE:NIO). The story, however, seems quite different for Chinese companies listed at home. The MSCI China Index is up just 20% since the beginning of the year.
Investors should see this as an opportunity.
That’s because the divergence between traditional Shanghai listings and U.S. ADRs should eventually narrow. U.S. listings won’t outperform their locally-listed counterparts forever. Already, companies like Ant Financial are looking to list only on the Hong Kong and Shanghai exchanges.
China also looks set to have a good 2021. Though the government’s heavy-handed reaction to Covid-19 caused massive short-term pains, the country managed to bring the pandemic under control faster than any major economy.
ProShares MSCI EAFE Dividend Growers (EFAD)
Now, let’s get back to more traditional investments: conservative dividend growers. While these stodgy investments might not make you rich overnight, their consistency can help you win over the long run. This tortoise-versus-hare tradeoff has made countless lifelong investors very wealthy.
But there’s just one problem. Many of today’s high-yielding dividend companies in the U.S. fall into my three least favorite sectors: U.S. financials, energy and real estate (REITs). The coronavirus pandemic has battered these sectors, and their recovery looks long and hard.
That’s where ProShares MSCI EAFE Dividend Growers come in.
Unlike the U.S. based Dividend Aristocrat Index (BATS:NOBL), EFAD follows dividend companies in international developed regions, particularly the Eurozone and Japan. And that means the index tracks a wide range of non-energy companies, such as software maker SAP (NYSE:SAP) and drugmaker Novartis (NYSE:NVS). Energy makes up less than 2% of total index holdings.
EFAD’s dividend yield also looks good in comparison: 2.89%, compared to the Dividend Aristocrats’ yield of 2.71%. If that’s not tempting, I don’t know what is.
Invesco S&P500 Equal Weight Tech ETF (RYT)
Investors looking for a diversified tech index should consider RYT, the Invesco S&P500 equal-weight tech ETF. It’s an index that spreads risk out across 500 different companies.
That’s in stark contrast to market-weighted ETFs, which tend to put their eggs all in one basket. The S&P Information Technology ETF, for example, allocates 41% of its fund to Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL). A stumble by either tech giant would quickly send the index crashing down. And why should an investor go through the trouble of buying an ETF with an annual fee when you can buy the individual stock?
That’s the reason I’m a fan of RYT, which allows investors to own a larger slice of the tech universe. Holders will own a diverse group of companies, ranging from IPG Photonics (NYSE:IPG) to Nvidia (NASDAQ:NVDA).
Now here’s the catch: equal-weighted tech index funds typically perform worse than market-weighted funds. That’s because, in the tech world, winners tend to keep winning. It’s much like buying Apple stock and selling too quickly — you miss out on the massive gains. But it also means that equal-weighted index funds tend to pick up on younger companies. With tech giant stocks up so much in 2020, it’s worthwhile looking into smaller companies as we enter 2021.
SPDR S&P Biotech ETF (XBI)
Traditional pharmaceutical companies used to dominate healthcare. Names like Pfizer (NYSE:PFE) relied on small-molecule drugs like Viagra to churn out billions in profits. Over the past decade however, healthcare has seen a massive shift towards biotech. Biologic drugs like Humira and Keytruda now dominate their industries.
Nowhere has this been clearer than in the endeavor to develop a coronavirus vaccine. Biotech companies large and small now dominate the race to vaccinate the world against Covid-19.
And 2021 looks to be another phenomenal year for biotech. Not only will successful Covid-19 vaccine makers get rewarded for their research today; the vaccines they make will serve as a platform for future drugs, such as cancer cures and flu vaccines.
So, how can investors know which biotech will win? In short, it’s hard to tell unless you specialize in drug research.
For the rest of us, XBI provides a solid entry point. The ETF buys a modified equal weight of biotech companies. That means it spreads risk more widely than its competing ETF, iShares Nasdaq Biotechnology ETF (NASDAQ:IBB), a market-weighted index.
It also means XBI has a broader exposure to small biotech companies which could potentially grow 100x or more.
S&P Small Cap 600 Value ETF (IJS)
At the other end of the spectrum, value-seeking investors should consider IJS, an index tracking small-cap value companies in the U.S.
That’s because small-cap value companies have two significant catalysts coming in 2021. Firstly, there’s the coronavirus vaccine. Even though a return-to-normal might feel years away for those stuck at home, experts believe that vaccines will become widely available by mid-2021.
Secondly, the U.S. Senate will likely pass a coronavirus stimulus package in Q1 2021. And as shown by the CARES Act, stimulus packages aimed at consumers and small businesses have a substantial effect on consumer demand. That’s particularly important for smaller companies, which don’t have the same access to capital markets as their larger counterparts.
Small companies have also proven themselves to be great investments. According to Jefferies, an investment bank, small-cap companies tend to outperform larger ones by 6% per year. And those small differences add up over time. $1,000 growing at 10% per year will turn into $2,593 after ten years. The same $1,000 growing at 16% will balloon into $4,411.
iShares MSCI Frontier 100 (FM)
Speaking of small companies, even active investors should consider buying shares of FM, the MSCI Frontier Index. That’s because this index fund tracks companies based in Frontier Markets — stocks that most individual investors can’t buy individually.
Frontier markets include countries from Vietnam to Kuwait, which are even less developed than emerging markets (including the likes of China, India and Mexico). And growth for these markets looks robust. For example, Vietnam’s GDP looks set to grow at 6% in 2021 or three times faster than the U.S.
These developing markets can offer some incredible investment opportunities. Safaricom, Kenya’s largest telecom company, posted a 20% earnings growth rate in 2020 as users flocked to its M-Pesa mobile payments platform. Meanwhile, Vietnam Dairy Products has seen local demand grow by almost 10% per year as the growing Vietnamese middle class finds its taste for milk.
Even better, investors can own these growth companies for cheap. The average FM company has an 11x P/E ratio and a 3% dividend yield. Even if you’re not a fan of milk, that’s a pretty tasty-looking yield.
Vanguard Total International Stock ETF (VXUS)
Finally, investors looking for diversified growth should consider VXUS, an index that tracks companies based outside the U.S. The broad-based index fund covers 6,977 companies, making it one of the most comprehensive in the world.
VXUS provides a good counterbalance for those who already own a lot of U.S. stocks. There are three reasons. Firstly, there’s risk mitigation. VXUS has no direct U.S. holdings, so American investors are less likely to double up on companies they already own.
Secondly, this international index is cheap. Its P/E ratio sits at just 16.3x compared to 24.8x in the U.S. Finally, the IMF expects other countries to recover faster than the U.S. in 2021. While U.S. growth might hit 3.1% next year, global growth should outpace the States at 5.4%.
There are also additional benefits to investing in one of the world’s largest international ETFs. Thanks to the fund’s size, VXUS has an expense ratio of just 0.09%. Rival iShares MSCI ACWI ex US ETF (NASDAQ:ACWX), by comparison, has a 0.40% expense ratio. The average volume for VXUS is also high at almost 3 million shares traded daily, meaning investors can quickly move in and out of the ETF as needed.
With a myriad of choices, investors should have no trouble finding diversified index funds for growth in 2021.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.