Investing a grand? Smart ETF Choices to Consider before 2025 Commences.
Investing a grand? Smart ETF Choices to Consider before 2025 Commences.
The stock market has been doing exceptionally well over the past couple of years. The S&P 500 is on the verge of delivering back-to-back years of more than 20% gains, while the tech-focused Nasdaq-100 index has nearly doubled since 2023's beginning. Despite the possibility of a market pullback in the next year, its overall trend is to bounce back from any downturns and hit new highs.
Investors can opt for exchange-traded funds (ETFs) that focus on the S&P 500 or Nasdaq-100 in anticipation of further growth. However, a more intelligent move would be to invest in ETFs that could benefit from a significant trigger in 2025. A potential trigger with substantial impact is the predicted decrease in interest rates, as the Federal Reserve continues to lower the benchmark federal funds rate, albeit at a slower pace than anticipated. This scenario should positively affect income-focused funds, which primarily consist of dividend-paying stocks, bonds, and real estate assets. Here are three ETFs to consider purchasing to take advantage of this potential catalyst:
Higher income at a reasonable cost
Dividend-paying stocks have underperformed the market this year. One of the main reasons is the impact of interest rates on the valuations of higher-yielding dividend stocks. For instance, the Schwab U.S. Dividend Equity ETF (SCHD -0.87%) was already lagging behind the S&P 500's total return before its recent dip:
As a result, the disparity in valuation between the two has widened. Schwab's ETF has an average price-to-earnings ratio of 18.4, much lower than the broader market index, which has a tech-heavy composition, resulting in a ratio of 25.8.
The dividend ETF also offers a much higher dividend yield – 3.3%, compared to 1.2% for the S&P 500. A $1,000 investment in this fund would result in approximately $33 in dividend income in 2025. This contrasts with only $12 in dividend income from an S&P 500 index fund. The higher income will help offset any potential losses in the event of a market correction the following year.
This income stream is likely to grow in the coming year due to the fund's focus on high-quality, high-yielding dividend stocks with a proven track record of increasing their dividends. Moreover, the value of the Schwab U.S. Dividend Equity ETF should appreciate as rates decline, thereby boosting the fund's total return potential.
Low-risk income source
Bonds are highly responsive to interest rate changes, experiencing price increases when rates decrease. Since lower rates may result in higher total returns for bonds, they present a lucrative investment opportunity next year if the Federal Reserve continues to lower interest rates.
The Vanguard Total Bond Market ETF (BND 0.39%) is a great tool to diversify your bond portfolio. The fund includes over 11,300 bonds, with almost 70% of its holdings backed by the U.S. government and the remaining bonds from investment-grade corporate issuers. This makes these bonds low-risk investments.
The bonds currently offer an average yield to maturity of 4.6%. With this rate, a $1,000 investment would yield around $46 in interest income over the next year. Furthermore, as interest rates rise, the value of the bonds should also appreciate, enhancing an investor's total return potential in the coming year.
Income and growth from real estate
Like bonds and dividend stocks, the value of commercial real estate is significantly influenced by interest rates. Real estate values have experienced a downturn in recent years due to higher rates. However, with rates starting to decrease, commercial real estate values should recover in the next year.
The Vanguard Real Estate ETF (VNQ -0.50%) is a suitable option to capitalize on a potential real estate upturn. The fund primarily invests in real estate investment trusts (REITs), which own large commercial real estate portfolios. The fund currently holds more than 150 REITs.
REITs normally pay above-average dividends due to IRS requirements that they distribute at least 90% of their taxable net income to investors annually. As a result, the fund provides an appealing income yield of 3.3%.
Additionally, the fund's value should increase in the upcoming year thanks to the improvement in real estate values. This could lead to the ETF producing strong total returns. Over the long term, REITs have historically outperformed stocks. With their current low values, there is a higher probability that REITs will outperform stocks moving forward.
Investment options with compelling potential for 2025
The Federal Reserve seems to be preparing to lower interest rates again in the following year, in spite of reducing its expectations from four cuts to two. This catalyst should boost the value of income-focused investments such as dividend stocks, bonds, and real estate. Consequently, ETFs specializing in these assets, such as Schwab U.S. Dividend Equity ETF, Vanguard Total Bond Market ETF, and Vanguard Real Estate ETF, appear to be smart investment choices as we approach the new year. They may outperform broader market ETFs if stock prices experience a pause.
Given the predicted decrease in interest rates by the Federal Reserve, it would be wise for investors to consider putting their money into income-focused funds that primarily consist of dividend-paying stocks, bonds, and real estate assets. For instance, the Schwab U.S. Dividend Equity ETF (SCHD) has a lower price-to-earnings ratio and offers a higher dividend yield than the S&P 500, making it a potential lucrative choice for those seeking higher income at a reasonable cost. Additionally, with lower interest rates, bonds, such as the Vanguard Total Bond Market ETF (BND), could prove to be a lucrative investment opportunity due to their increased total returns.