5 ETFs for the Recovery
Hooray! Maybe the sky's not falling after all. The market enthusiastically greeted news that the U.S. economy continued to grow during the third quarter and showed little danger of falling back into recession. Initial data from the BEA showed that GDP rose by 2.5% in the third quarter of the year. Consumer spending, which accounts for a huge portion of GDP, posted solid numbers for the quarter, and while some of this may just be a bounce-back effect from the moderation of oil prices and the end of supply-chain disruptions following the tsunami in Japan this spring, the current spending pace bodes well for future quarters.
At any rate, at least for the moment, it appears as if the economy is successfully skirting a double-dip recession. While the fiscal troubles in the eurozone remain a wild card, I believe that the economy will continue on its current path of slow, subpar growth rather than slipping back into contraction. In that scenario, investors will need to ensure that they have exposure to the areas of the market that are most likely to thrive in the next stage of the recovery. If you're looking for a quick and easy way to get this exposure, look no further than a handful of inexpensive and easily traded exchange-traded funds.
If there's one thing that's fairly certain with respect to relative valuations among asset classes, it's that the small-cap sector is much more richly valued than the large-cap segment of the market. In fact, managers Bill Nygren and Kevin Grant of the Oakmark Fund (OAKMX) believe that the current P/E discount for large-cap stocks compared to mid- and small-cap names is one of the widest in decades. And given that financially stable large-cap companies typically outperform once a bull market matures and the initial stages of recovery are over, there's a lot of potential in this area.
With that in mind, a large-cap-focused ETF like SPDR S&P 500 ETF (NYS: SPY) or the Vanguard Large-Cap ETF (NYS: VV) should be a part of your portfolio. Both funds focus on several hundred of the largest stocks in the U.S. market, so you'll get wide coverage across multiple industries and sectors here. Turnover is low at both funds, making them suitable for taxable accounts as well as tax-advantaged ones.
And the best part is, costs are practically next to nothing. The SPDR will run you 0.09% a year, while the Vanguard ETF will only set you back 0.12%. And lower costs mean more profits for you! Now if you're in retirement, you might want to target a roughly 20% allocation to large-cap domestic stocks; if you're much younger with a few decades left to go in your career, something closer to 35%-40% is probably more appropriate. Whatever your life stage, make sure you have adequate exposure to the very reasonably valued large-cap market.
It's all about the dividends
Of course, if you want to home in on the large-cap market even more, there's a special subset of big-name stocks getting a lot of attention from investors right now: dividend-producers. And these stocks are getting attention for all the right reasons. Historically, stocks that have paid out dividends have outperformed those that don't. In fact, according to research by Massachusetts-based investment managers Thomas Partners, in the 40-year period from 1971 to 2010, stocks that increased their dividends returned an annualized 14.1%, while stocks that maintained a consistent dividend payment posted a 9.9% gain, and stocks that paid no dividends at all only saw a 3% return. And given that dividend payout ratios are currently below the historic average, there is likely to be plenty of room for companies to raise their dividends in the coming years.
To get access to a wide-range of dividend-paying stocks in one stop, think about picking up an ETF that fishes in these waters. Two good choices here are the Vanguard Dividend Appreciation ETF (NYS: VIG) and the SPDR S&P Dividend ETF (NYS: SDY) . With low expense ratios of 0.18% and 0.35%, respectively, you'll get the most bang for your investment buck. The SPDR has a slightly higher trailing 12-month yield, at 3.4%, compared to 2.2% for the Vanguard fund, but both are good options to capture any potential trend of increasing dividend payouts.
And finally, while focusing on domestic large-cap dividend payers will probably do a lot to boost your portfolio, you don't want to miss out on all the dividend action that's taking place overseas. To capture some of the power of foreign dividend-producers, you might want to consider a fund like PowerShares International Dividend Achievers (NYS: PID) . This ETF does has some small exposure to U.S. names, but it focuses primarily on foreign stocks with high dividend yields, as indicated by its trailing 12-month yield of 3.8%. Right now, names from the U.K. make up roughly a quarter of fund assets, while Canadian stocks account for another 19%. Further down the line, both Israeli and Mexican companies account for 5% of assets apiece, so you know you're getting some decent emerging-markets exposure here, too. The fund's 0.50% price tag isn't as cheap as most domestic-focused ETF options, but the cost should be more than worth it, given the expanded exposure it will provide for your portfolio.
It's way too soon to declare that the economy is on track to anything resembling a robust recovery, but continued sluggish growth appears to be the order of the day. Make sure you have the investments that are best suited to thrive in such an environment.
At the time this article was published Amanda Kishis the Fool's resident fund advisor for the Rule Your Retirement investment newsletter service. Amanda owns shares of the Oakmark Fund.The Motley Fool has sold short shares of SPDR S&P 500. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.
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