How should a beginner invest in stocks? Get started with this ETF.

A great way to create long-term wealth is through investing. But it is not necessarily an easy way, especially for beginners. For those just starting out, finding the right individual stocks to invest in can seem a bit overwhelming.

JP Morganinvestment firm published a study in 2021 that found that 40% of companies in Russell 3000 the index, which tracks the 3,000 largest-traded stocks in the U.S., saw a catastrophic price loss between 1980 and 2020. It defined it as a loss of 70% or more from which stocks never recovered for to reach new highs. Meanwhile, more than 40% of stocks posted negative returns during this period, and two-thirds of stocks underperformed the index. There are a lot of stocks that haven’t done well at all.

While a lot of individual stocks have underperformed, stock indices such as S&P 500 have produced extraordinary profits over time. The S&P has managed to generate an average annual return of 13% over the past decade (end of August 2024), or nearly 239% on a cumulative basis.

How can the S&P 500 do so well when so many individual stocks are struggling?

The answer has to do with how the index is compiled and maintained. The S&P 500 is market-cap weighted, meaning it lets its winners run and become a larger percentage of its holdings, while its losers get smaller until they eventually quit.

About 10% of the companies named megawinners in the JP Morgan study are those that outperform the general market. These mega winners are stocks that have outperformed the Russell 3000 by 500% or more over the period studied.

Image source: Getty Images.

So where should new investors put their money?

So the S&P 500 is projected to outperform this market as a whole. This fact leads most experts to advise new investors to start investing in an exchange-traded fund (ETF) that tracks the S&P 500. After all, it is a large and popular index with a history of solid returns.

But I’m not like most experts, and I think there’s an even better ETF that new investors should focus on: Vanguard Growth ETF (VUG 0.38%). This ETF tracks only the components of the S&P 500 index that qualify as growth companies (about half of them). The ETF has well outperformed the S&P 500 over the years, with an average annual return of 15.1% over the past 10 years. While that might not sound like much more than the S&P’s 13% return, on a cumulative basis it equates to a return of nearly 307% (compared to 239%).

A $10,000 investment in this growth ETF a decade ago would be worth nearly $40,700 today. The same investment in an ETF that tracks the entire S&P 500, such as Vanguard S&P 500 ETF (VOO 0.53%)it would be worth about $33,750. This is a significant difference.

The Vanguard Growth ETF is the better option because of JP Morgan’s notion of mega winners fueling the market. When you look at the largest companies trading in the US, most are classified as growth stocks. The only companies not classified as development companies among the top 10 holdings of the S&P 500 are Berkshire Hathaway and (weird) Broadcom.

But it is about growing companies like Apple, Nvidia, Microsoftand Amazon which have grown to become the largest companies in the world by increasing their revenues and profits at rapid speeds. And many of the top holdings on the value side of the S&P were previously in the growth category, such as Walmart and Home Depotwhich have just matured.

S&P 500 ETFs give investors exposure to potential mega-winners, but the Vanguard Growth ETF offers slightly more exposure to these stocks, leading to higher performance over time.

For this reason, I think the Vanguard Growth ETF is a great place for new investors to start their investment journeys. By using a dollar-cost averaging strategy of putting money into the index with every paycheck or every month, new investors can build a lot of wealth for years to come.