When investors think about owning the market, the go-to exchange-traded fund (ETF) or mutual fund is usually an S&P 500 (^GSPC 0.16%) index tracker. That's not a bad call at all, but there are other ways to get exposure to the market that are a bit more nuanced. Here's a look at why the S&P 500 index is such a good market gauge, and why shifting to the Invesco S&P 500 GARP ETF (SPGP -0.25%) could be a better long-term call.
What is the S&P 500 index?
The original market tracking tool was the Dow Jones Industrial Average (^DJI 0.25%). It consisted of 30 stocks that were large and representative of the broader economy. Because of when it was created, however, the math behind the index is kind of odd (at least by today's standards). The Dow 30 is basically weighted by the size of a company's stock price. So the highest-priced stocks have the largest effect on the index's performance.
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That's not ideal, and it's one of the issues that the S&P 500 index fixed. The S&P 500 index is weighted by market cap, so the largest companies have the greatest effect on performance. That's far more in line with how the economy works. The other big problem was the fact that the Dow 30 index was pretty small, with only 30 stocks. The S&P 500 index expanded that out to 500, creating a far more diversified market tracking gauge. The S&P 500 index pretty quickly became the gold standard -- even though, perhaps surprisingly, the Dow 30 and the S&P 500 index tend to move fairly similarly over the long term.
If you were looking for an index fund to hold for a lifetime, an S&P 500 index tracker would be a great choice. You can use a mutual fund, like the Vanguard 500 Index Fund, or an ETF, like the SPDR S&P 500 ETF Trust (SPY 0.15%), and get the job done fairly well. But what if there were an even better alternative?
What does the Invesco S&P 500 GARP ETF do?
As the chart above highlights, the Invesco S&P 500 GARP ETF has beaten the S&P 500 index over the longer term. That is in terms of both share price performance and total return, which assumes dividend reinvestment. That's pretty impressive and something that most actively managed funds don't achieve. The Invesco S&P 500 GARP ETF tracks the S&P 500 GARP Index.
The thing is, the starting point for this index is the S&P 500 index. So it is basically cherry picking stocks from the larger pool to create a more focused offering with just 75 or so holdings. The screening method here focuses on identifying growth at a reasonable price, or GARP, stocks. This is handled by creating a growth score for all of the 500 or so stocks in the S&P 500 index, looking at three-year earnings-per-share growth and three-year sales per share growth. The 150 stocks with the highest growth scores make it through to the next step.
In the second step, a quality/value score is created for each of the 150 stocks. This score looks at a company's financial leverage, return on equity, and price-to-earnings ratio. The 75 companies with the best quality/value scores make it into the final index, weighted by their growth scores.
Thus, you have the Invesco S&P 500 GARP ETF's portfolio. It is, basically, an index made from an index that blends growth and value. Impressively, it has outperformed the larger S&P 500 index over the long term. As the chart below highlights, however, the Invesco S&P 500 GARP ETF is lagging behind the broader S&P 500 index of late.
Nothing works in every market
If you are trying to find a single index fund to own forever, you need to go in with a clear understanding of how Wall Street works. Stocks swing in a pendulum like fashion, so there's no one index that will always win. However, the S&P 500 index is a fairly good gauge of long-term market performance. It's also a super starting point if you want to focus on a smaller group of companies, like the Invesco S&P 500 GARP ETF does.
Growth at a reasonable price is a nuanced way to look at the S&P 500 index, but it's a methodology that will probably feel pretty comfortable for most investors. However, like all investment approaches, it won't always be the best-performing investment approach. That said, sometimes the best time to buy is when something is out of favor. That's the case right now with the GARP take on the S&P 500 index. If you think in decades and not days, now could be the time to add the Invesco S&P 500 GARP ETF to your portfolio, before the pendulum swings back in the GARP approach's favor.
