Round out your large-cap U.S. stock fund with this ETF

This well-diversified offering pairs well with the S&P 500.

Adam McCullough, CFA 18 September, 2018 | 5:00PM

Mid- and small-cap stocks are usually riskier investment propositions than their large-cap brethren. They tend to have less-established competitive advantages and are more sensitive to the economic cycle. But they offer diversification benefits and may compensate investors with higher returns.  Vanguard Extended Market ETF (VXF) is an excellent choice for exposure to U.S. stocks that land outside of the S&P 500. This fund achieves a leg up over its peers by efficiently tracking a broadly diversified index at a low fee. It earns a Morningstar Analyst Rating of Gold.

The fund tracks the S&P Completion Index, a broad market-cap-weighted index that represents nearly every U.S. stock outside of the S&P 500. Market-cap weighting skews the fund toward the index's largest names, but it reaches further down the market-cap spectrum than most mid-cap U.S. equity funds and straddles the mid- and small-cap size segment breakpoint. Indeed, its average market capitalization is about half of the category average. The fund's broad reach and market-cap weighting should help it effectively diversify firm-specific risk.

By using market capitalization to weight its holdings, the fund relies on the cumulative knowledge incorporated in stock prices to size its positions. While market participants have done a good job valuing stocks over the long term, the market has gone through episodes of mania and panic. But this risk is worth the cost advantage gained from market-cap weighting. Market-cap-weighted index funds are cheaper to run than most actively managed funds because they require fewer investment personnel and their low turnover translates to low transaction costs. The fund's turnover during the past decade measured a fraction of the average fund in the category.

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About Author

Adam McCullough, CFA

Adam McCullough, CFA  Adam McCullough, CFA, is a manager research analyst for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He covers passive strategies.

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