Key Takeaways
- Growth ETFs often offer higher returns but come with greater risk.
- Value ETFs are more conservative and may perform well in volatile markets.
- Assess the expense ratio of ETFs as they affect your returns.
- ETFs may have low fees but could stray from their benchmark.
- With ETFs, you cannot choose individual assets for ethical concerns.
When looking to add an equity-focused exchange-traded fund (ETF) to a portfolio, you usually have to choose between one of two broad categories: growth and value.
Value ETFs look to invest primarily in the stocks of companies that are trading below their intrinsic worth, compared to either their peers or the broader market—using metrics such as the price-to-earnings (P/E) ratio. Growth ETFs, in contrast, focus on investing in fast-expanding, and often more volatile, companies in hopes of realizing above-average returns.
Both of these strategies can yield market-beating returns. Your risk tolerance, investing goals, and current portfolio composition are the most important factors in determining whether to add a growth or value ETF to a portfolio. Generally speaking, having both value and growth ETFs in a portfolio provides valuable risk-reducing diversification benefits.
Understanding Value ETFs
A big factor in choosing between growth and value is the state of your current portfolio. If you’re starting out, build a portfolio around a core of highly rated value ETFs. These funds tend to consist of companies that produce products used every day by just about everybody.
Examples of traditional value stocks include AT&T (T), Procter & Gamble (PG), General Electric (GE), and Coca-Cola (KO). These companies look to provide conservative long-term growth with comparatively lower volatility.
Another benefit of adding value ETFs to a portfolio is their dividend yields. These companies tend to be bigger cash flow generators, and that cash flow often gets paid out in the form of dividends. Dividends provide you with a predictable income stream that can become a significant percentage of a value ETF’s overall shareholder return.
Important
With all ETFs, pay attention to the expense ratio, as those are the fees you pay that reduce your returns. The lower the better.
Exploring Growth ETFs
Growth ETFs generally complement a core portfolio. Growth companies such as Tesla (TSLA), Meta (META), Amazon (AMZN), and Alphabet (GOOGL), though fairly established by now, can deliver above-average returns.
Growth stocks also come with a great deal of volatility and can struggle, especially in times of economic weakness. Some other growth companies that are not as popular as the above-mentioned tech giants include Builders FirstSource (BLDR), Encore Wire (WIRE), Clearfield (CLFD), and Onto Innovation (ONTO).
A portfolio consisting primarily of growth ETFs can expose you to excessive risk, but when balanced with value ETFs, they can create an appealing risk/return profile.
If you’re seeking a regular income from a growth ETF, you’re more likely to be disappointed. Many growth-oriented companies reinvest available cash back into growing the business instead of paying profits out to shareholders directly. Many of these companies pay little, if anything, in regular dividends.
How to Decide Between Growth and Value ETFs
If you have difficulty stomaching regular market fluctuations, stick with a more conservative, value ETF. If you’re comfortable with more volatility as a way to achieve above-average returns, you may prefer a higher allocation to growth ETFs.
Examine what the fund typically invests in and how it is managed. A fund with a manager who has been at the helm for several years provides a track record of historical performance and a sense of how the fund is managed.
Some funds, for example, are categorized as value funds but carry large allocations to riskier sectors like technology. Make sure you know what you are buying. Also, consider a fund’s expense ratio. Fund expenses cut directly into returns; avoid funds with above-average expense ratios.
Time horizons should also be a consideration. You can generally take more risk if your money stays invested longer. Longer time horizons allow you a better chance to ride out short-term market volatility. Younger investors adding to an individual retirement account (IRA), for example, have decades to remain invested and can take some additional risk to pursue higher returns.
Choosing between a value and growth ETF is only part of the decision-making process. Choosing the right ETF is equally important.
What Are Good Growth ETFs?
Some good growth ETFs for consideration are the Vanguard Russell 1000 Growth ETF (VONG), the iShares Morningstar Mid-Cap Growth ETF (IMCG), the Vanguard Mid-Cap Growth ETF (VOT), and the First Trust Nasdaq-100 Equal Weighted ETF (QQEW). Remember, with all investments, to check if they suit your investment goals and risk profile, and that past performance is never indicative of future performance.
What Are Good Value ETFs?
Are There Downsides to Investing in ETFs?
Overall, there is little downside to investing in ETFs; however, with all investments, there are some risks. ETFs come with fairly low fees, making them fairly affordable for the average investor. Keep an eye on fees and avoid funds that have high ones unless those fees are truly justifiable.
Additionally, some ETFs can stray from their benchmark and have poor tracking errors, which defeats the purpose of the ETF. Furthermore, ETFs provide little control—you don’t get to choose which assets make up the ETFs. So if there are specific companies you want to avoid for moral reasons, that may be difficult to do.
The Bottom Line
Both value ETFs and growth ETFs can be good investment choices. They offer different risk profiles and investment returns, with each hopefully bringing a nice return to an investor. Choosing between the two comes down to individual preferences based on investment goals, current portfolio construction, and risk tolerance. Having both in your portfolio would be an overall good bet.