A great ETF can transform your retirement account. Most of the popular ETFs are fine investments that can deliver strong long-term returns and diversification, but not all funds are created equal. ETFs are designed for a wide range of strategies and niches, and some are suited perfectly for a 401(k) or IRA.
Characteristics to prioritize
When you get to retirement, your investment accounts should turn into income-generating machines that balance growth volatility. In the decades leading up to retirement, however, your retirement account should prioritize growth. Long time horizons allow investors to endure some volatility and ride out market cycles, because temporary downturns ultimately give way to long-term market growth. It's important to limit investment risk in retirement accounts, so it's best to avoid any portfolios that are too focused on speculative payoffs.
For this reason, good ETFs for your retirement accounts should have a history of outpacing the returns of major market indexes. The best ones accomplish this without taking on too much extra risk. There's generally a trade-off between risk and reward, so funds that can deliver strong results on both fronts are rare and valuable.
Invesco S&P 500 GARP ETF
The Invesco S&P 500 GARP ETF (NYSEMKT: SPGP) is an interesting fund that checks those boxes. GARP stands for “growth at a reasonable price.” That sounds great on the surface, but the ETF also backs up that claim. The fund's managers follow a specific methodology that delivers exactly what the name indicates.
The ETF's managers rank growth stocks from the S&P 500 with a proprietary scoring index. That score is based on growth, quality, and valuation metrics. The selection starts by identifying the top 150 stocks with the highest growth scores. Of those 150 stocks, the fund invests in the 75 that score the highest in quality and value metrics.
The portfolio is then weighted based on the score, rather than market cap. No stock can make up more than 5% of the total allocation, and no sector is allowed to exceed 40% of the portfolio. At this time, it's heavily skewed toward healthcare, finance, electronics, and tech stocks.
The result is a relatively small number of holdings that combine a fairly rare set of characteristics. The selection methodology slices away some of the mature, slow-growth stocks in the S&P 500. It also eliminates exposure to growth stocks that have highly speculative valuations. This leads the fund to missing out on some of the biggest winners, but it also eliminates the possibility of chasing unsustainably aggressive valuations and momentum stocks that eventually crash back to earth. By avoiding market-cap weighting, the fund also reduces correlation to the major indexes.
This approach borrows elements from multiple successful strategies. Growth investors are obviously covered with the selection process. People who like factor investing and smart beta probably enjoy the quality and factor elements that have been correlated to strong performance historically. Even index investors should like the idea of a portfolio with 75 holdings and no single stock dominating the allocation.
Those characteristics have translated to strong results. The Invesco S&P 500 GARP ETF has outpaced the S&P 500 during bull markets, and it's holding up much better than its growth peers now that the market is tumbling.
The fund's P/E ratio is under 16, which is low enough to partially protect it from the growth sell-off. For comparison, the P/E ratio for the Vanguard Growth ETF is around 38, so there's clearly a huge difference in allocation from other growth peers.
The Invesco GARP fund is doing something different, and its results have been stellar. That's usually a recipe for success. Before diving in, investors should be aware of the Invesco S&P 500 GARP ETF's 0.36% expense ratio. That's not outrageously high, but it's much higher than some of the razor-thin expense ratios available in the Vanguard family of funds. It delivers value that's worth the cost, but it's something to keep in mind.
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