Uncover the Hidden Gem: Why This Overlooked Index Fund Outperforms the S&P 500

In the world of investing, the advice to simply buy and hold an S&P 500 index fund like the SPDR S&P 500 ETF Trust (NYSEMKT: SPY) is a common refrain. And for good reason – it’s a straightforward strategy that helps investors avoid the risks associated with picking individual stocks. However, for those looking to maximize their long-term returns, there’s a lesser-known option that may offer even greater potential upside.

Enter mid-cap exchange-traded index funds like the SPDR Portfolio S&P 400 Mid Cap ETF (SPMD) and Vanguard S&P Mid-Cap 400 ETF (IVOO), which track the S&P 400 MidCap index. These funds provide exposure to companies with market capitalizations between $2 billion and $10 billion, offering a unique opportunity to tap into the often-overlooked mid-cap segment of the market.

Historical data reveals that the S&P 400 index has actually outperformed its larger counterpart, the S&P 500, by nearly two to one since 1991. While the average annual return of the S&P 400 may not be significantly higher than that of the S&P 500, the compounding effect of the additional gains generated by mid-cap stocks over time can lead to substantial outperformance.

So why do mid caps tend to outperform large caps? The answer lies in the growth potential of companies in this size range. Mid-cap companies are typically in a sweet spot of their development, poised for growth but not yet fully mature. This growth potential can translate into significant returns for investors, as evidenced by the success stories of companies like GoDaddy, Super Micro Computer, and Fortinet, all of which started in the mid-cap space before graduating to the S&P 500.

While not every mid-cap stock is a winner, the overall upside of mid-cap winners tends to outweigh the downside of losers, making mid-cap index funds an attractive long-term investment option. By diversifying your portfolio with exposure to the mid-cap segment of the market, you can potentially enhance your returns and mitigate risk.

In conclusion, while holding a large-cap index fund like the SPDR S&P 500 ETF Trust is a solid investment strategy, adding a mid-cap index fund like SPMD or IVOO to your portfolio can offer even greater potential upside. With historical data supporting the outperformance of mid caps and the growth potential of companies in this size range, investing in mid-cap index funds may be a prudent move for long-term investors looking to maximize their returns.