Why this ETF is my #1 recommendation for new investors | Personal Finance

Of course, even if you’re just ready and able to take the plunge for a short time, you’re probably aware that there’s no shortage of advice out there. Most of them are well-intentioned, and some of them may even be called “good.” However, if any of these include recommendations for individual stocks as your foray into investing, take a moment to seriously consider another tip you may have heard by now: buy index funds that represent a broad share of the market.

However, the index fund I’m going to recommend is not one that I’m sure has gotten such a strong recommendation from other sources.

You may have read or heard SPDR S&P 500 ETF Trust (NYSE: SPY) is a great way to start your investment journey. To be honest, if this is the choice you end up making, you do have a good start. This exchange-traded fund (ETF) contains approximately 80% of the total stock market value, allowing you to participate in the continued (albeit cyclical) growth of the economy without forcing you to be a stock picker.

But if you don’t like to go with the flow, you might be better off iShares S&P MidCap 400 Index Fund (NYSE: IJH).

Some seasoned investors might be surprised by this choice because it’s a better place to start, but there are specific reasons why mid-cap funds might be a smart choice for newbies.

The S&P 500 is made up of companies that are considered large caps, while the S&P Midcap 400 is made up of mid-cap companies in the United States. It’s not a hard and fast rule, but generally, these organizations have market caps between $2 billion and $10 billion. That’s enough to ensure they’ll be around for a while, but too small to capture the attention of most investors (and the media).

While the S&P 500 companies account for about 80% of the stock market’s value and earnings, the second-largest 400 companies that make up the S&P 400 together account for 10% to 15% of the total US stock market value.

Still, it’s a particularly strong segment of the investable market. As S&P explains for its indices: “Midcap exposure typically reflects a stage in a typical business life cycle in which companies successfully navigate challenges specific to smaller companies, such as raising initial capital and managing early-stage growth. .” However, S&P added, “At the same time, mid-cap stocks tend to be dynamic and not large enough for sustained growth.”

In short, many of these organizations are in the sweet spot for investors.

This unique advantage is reflected in the long-term performance of ETFs. Nearly 300% of the SPDR S&P 500 ETF trust’s return has mirrored that of the index it represents since the turn of the century, but the midcap 400 index fund has nearly doubled its performance.

But don’t get too excited. Take a close look at the chart.maybe a few months even some years When mid-cap stocks lag large-cap stocks. For example, these mid-cap stocks have been underperforming since COVID-19 ravaged the world, creating challenges that are easier for larger companies to overcome.

But if you’re really going to be in the market for the long term, these soft patches aren’t a problem.

As I mentioned above, shares in the SPDR S&P 500 ETF Trust are still a good bet. Or, perhaps the wisest option is to split the spread and own a portion of both investments. This way you don’t have to feel like you’re missing out on the unique advantages of either option.

This is no small matter.

Perhaps the biggest risk for new investors is that you can easily lose interest in long-term holdings when you feel that other options may end up doing better. However, since mid-cap positions have historically outperformed large-cap stocks, you still have a sensible, risk-adjusted opportunity to do so. This dynamic makes it at least less stressful when it’s psychologically difficult to stick with index-based investing…like after a sharp sell-off.

The temptation to try to time any trade entry and exit is even further reduced, considering that midcap and large caps as a group may not hit their major lows at the same time.

Regardless, the S&P MidCap 400 Index Fund still allows new investors to avoid the risky temptations of being a stock picker, especially without first establishing the right foundation for their portfolio.

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James Blumley has no positions in any of the stocks mentioned. The Motley Fool has no positions in any of the stocks listed above. The Motley Fool has a disclosure policy.