This Overlooked ETF Is Quietly Giving the S&P 500 a Run for Its Money

The S&P 500 (^GSPC -0.90%) is the most-followed stock market index by a wide margin, and it has a lot to like. It’s a hands-off one-stop shop that has consistently delivered impressive long-term returns. This year, the index is up 7.8% through Nov. 6, which is a step back from its huge gains over the past three years, but still not too shabby.

While the S&P 500 gets a lot of attention (both good and bad), many ETFs have overperformed but slipped under the radar as investors focus on the current artificial intelligence boom and the companies driving it. One is the Vanguard Russell 2000 ETF (VTWO -1.14%), which is up 12.5% so far this year with momentum on its side.

What you’re getting with VTWO

The Russell 2000 is the main index for small-cap stocks, as the S&P 500 is for large-cap stocks. It tracks the smallest 2,000 companies in the broader Russell 3000 index.

VTWO is a great way to invest in small-cap stocks because it offers the upside of small companies with room to run while reducing the higher risk that often comes with small-cap investing. Instead of having to pick “winners,” you can make one investment and get exposure to most of them in the market for only $0.60 per $1,000 invested.

While the S&P 500 has become heavily concentrated in tech (39.7%), VTWO is more diverse across sectors. Its top five sectors by representation are healthcare (20.6%), financials (18.4%), industrials (15.6%), tech (11.7%), and consumer discretionary (11.2%).

Most people won’t know many of the companies in VTWO, but you’ll come across familiar names like The Cheesecake Factory, Texas Roadhouse, and Victoria’s Secret.

A hedge play that has routinely paid off

Since VTWO began trading in September 2010, it has produced dependable returns. It has underperformed the S&P 500 over that period but has averaged 10.8% annual total return, which is impressive for a broad ETF. Even if it averages a more modest 8% annual return going forward, consistent investing will be nicely rewarded.

^SPX data by YCharts

I don’t expect VTWO to outperform the S&P 500 over the next decade or so, but it can be a great hedge against putting all your eggs in the big tech basket. The “Magnificent Seven” stocks alone account for over 34% of the S&P 500, giving them significant influence on the index.

VTWO adds diversification and puts you in a position to take advantage of the different growth opportunities that come with smaller companies. I wouldn’t have a large amount of my portfolio in small-cap stocks because of their high volatility and vulnerability during rough patches, but holding a small slice of VTWO makes sense.