This Low-Cost Vanguard ETF Has Doubled Since the Start of 2023, but Will the Momentum Continue Into the New Year?

Holiday cheer is in the market air, with the broader indexes making new all-time highs seemingly every day. But there was little to be merry about this time two years ago when many top growth stocks were performing terribly. Major sell-offs in 2022, paired with a sustained rally over the last two years, have made for some genuinely jaw-dropping two-year charts.

Since the start of 2023, the S&P 500 is up 58.5%, but the Vanguard Mega Cap Growth ETF (MGK 0.67%) is up 103.7%. meaning your money would have more than doubled in less than two years.

Here’s why this exchange-traded fund (ETF) has been such a standout performer and how to use the ETF in the best way for you.

Betting on a handful of market leaders

The top 10 holdings have grown so much in value that they now make up 65.5% of the Mega Cap Growth ETF. By its nature, the ETF is momentum-based because outperforming stocks will grow to become a larger share of the ETF. This is the same way that an index, like the S&P 500, works. The greater the value of the top holdings, the more they can move the index, whereas underperforming stocks gradually make up a lower share of the index. Twenty years ago, ExxonMobil was the largest U.S.-based company by market cap. Today, it makes up around just 1.1% of the S&P 500.

Being overweight megacap growth stocks has arguably been the simplest way to outperform the S&P 500 over the last few years. As you can see in the following chart, several megacap tech stocks have more than doubled during this period. In contrast, standouts like Nvidia, Meta Platforms, Tesla, and Amazon have delivered even larger outsize gains.

NVDA data by YCharts

The Vanguard Mega Cap Growth ETF is a simple way to bet on today’s market leaders remaining tomorrow’s market leaders. As you can see in the following table, the Mega Cap Growth ETF has significantly higher (and in some cases, close to double) the weights of the following 10 stocks than the Vanguard S&P 500 ETF.

Data source: Vanguard.

The S&P 500 has become more concentrated in megacap tech-focused companies, but nowhere near as much as the Mega Cap Growth ETF. The Mega Cap Growth ETF can be a useful tool for risk-tolerant investors because it is simple and straightforward. In other words, you know early what you’re getting to with this ETF. If these companies continue to lead the market higher, chances are this ETF will continue crushing the S&P 500. But if there’s a major sell-off in even one of these names, and there are ripple effects across the market, then the Mega Cap Growth ETF could undergo a steep sell-off, as it did in 2022 when it fell 34%.

Room for reconsideration

With just a 0.07% expense ratio — or $7 for every $10,000 invested — the Mega Cap Growth ETF can be an excellent way to put new capital to work in growth pockets of the market. However, a few factors are worth considering before diving headfirst into the fund. The first is duplication.

Let’s say that Nvidia makes up an eighth of your portfolio, and you’re looking to diversify into other growth stocks. Buying the Mega Cap Growth ETF would be a bad idea because an eighth of its holdings are also in Nvidia, so you would keep the same allocation.

Investors who already own comfortable amounts of these names but still want to target growth instead of value ETFs may want to consider a less top-heavy fund, such as the Vanguard Growth ETF. Other options include the Vanguard Mid-Cap ETF or the Vanguard Small-Cap ETF — both of which don’t hold any of these megacap names and could be good ways to diversify.

The second factor is valuation. Many mega-cap growth names have seen their stock prices outpace their earnings growth, which has led to expanded multiples. Expectations for strong earnings next year will pressure these companies to deliver. And if they do deliver, they could still sell off, as we saw with Nvidia after its latest print.

Some folks may want to consider investing in their highest-conviction growth stocks in addition to, or instead of, piling into the Mega Cap Growth ETF.

For example, Alphabet and Meta Platforms have price-to-earnings ratios below the S&P 500, making them more value-oriented options. Or if there’s an exceptionally high conviction mega-cap growth stock that you believe deserves a premium valuation (for me, it’s Microsoft), then it may be better to target that name.

The best way to approach top stocks during market highs

Investing in industry-leading companies through periods of volatility is an excellent way to compound wealth over time. Buying stocks at all-time highs can go against our instincts to get a good deal. But long-term investors can rest easy knowing that all of today’s market leaders can continue producing outsize gains through earnings growth. Earnings growth is the single greatest catalyst for justifying valuation expansion. And so far, this market rally has largely been driven by earnings growth.

Still, it’s essential to be aware that the gains we have seen over the last couple of years are not normal, so you should always invest in a company for its sound long-term investment thesis rather than to make a quick buck.