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 blowing 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 individual risk tolerances, 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.
- Both value and growth ETFs can be an important part of any portfolio, contributing to its diversification.
- The choice to focus on either value ETFs or growth ETFs comes down to personal risk tolerance.
- Growth ETFs may have higher long-term returns but come with more risk.
- Value ETFs are more conservative; they may perform better in volatile markets but can come with less potential for growth.
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, Procter & Gamble, General Electric, and Coca-Cola. 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.
Growth ETFs generally complement a core portfolio. Popular growth companies such as Meta (formerly Facebook), Amazon, and Alphabet can deliver above-average returns, but they also come with a great deal of volatility and can struggle, especially in times of economic weakness. 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.
Deciding 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.