The Best Stocks to Buy Have Historically Come From 1 Stock Market Sector. Here’s What Investors Should Know.

The S&P 500 (^GSPC -0.01%) measures the performance of 500 large U.S. companies that span all 11 stock market sectors defined by the Global Industry Classification Standard (GICS). Those sectors are listed alphabetically below:

• Communications services
• Consumer discretionary
• Consumer staples
• Energy
• Financials
• Healthcare
• Industrials
• Information technology
• Materials
• Real estate
• Utilities

Interestingly, one stock market sector consistently outperformed the rest over the past decade. In fact, the sector in question more than doubled the return of the broader S&P 500, and it was the only sector to beat the market.

Can you guess which one?

Technology stocks have consistently outperformed

The information technology sector has been the stock market’s growth engine over the past couple of decades. It crushed the other GICS market sectors over the last 10 years, and it is leading the S&P 500 higher again this year.

The chart below shows how profoundly the technology sector outperformed the other market sectors (and the S&P 500 itself) over the past decade.

^SPXIFTS data by YCharts

Some readers may see a problem. The S&P 500 is weighted by market capitalization, meaning larger companies have a greater impact on its performance. That poses a potential problem because many of the largest S&P 500 companies are classified as technology stocks. For example, Apple, Microsoft, and Nvidia alone constitute nearly 18% of the index.

That begs the question: Did technology stocks only outperform because a few big tech companies did well? The answer is no. The superior returns were broad-based.

The chart below shows the equal-weight performance of the S&P 500 market sectors over the past decade. In other words, the disproportionate impact of big tech companies is stripped away, such that each stock impacted the index in equal measure.

^SS4E data by YCharts

The data above is significant. It shows that the best S&P 500 stocks have historically come from the technology sector, and that is a very compelling reason to own technology stocks today. Investors looking for inspiration should consider the Fortune Future 50 List, an annual ranking of the world’s largest companies based on their long-term growth prospects.

The Fortune Future 50 List for 2023 positions five technology stocks among the top 10 spots, including Snowflake, Datadog, CrowdStrike, Cloudflare, and Bill Holdings.

To be clear, none of those technology stocks are guaranteed winners. Good decision-making requires research, and even then mistakes are possible. To quote famed investor Warren Buffett: “Successful investing takes time, discipline, and patience. No matter how great the talent or effort, some things just take time.”

Alternatively, investors can buy index funds, either in addition to or in lieu of individual stocks. Doing so would eliminate or minimize time spent on research and portfolio management.

Here are two index-fund-based strategies that could help investors capitalize on the market-beating potential of technology stocks.

1. Buy an index fund focused on technology stocks

The Vanguard Information Technology ETF (VGT 0.48%) tracks 318 technology stocks that fall into three broad categories: (1) software and services companies, (2) technology hardware and equipment providers, and (3) semiconductor and semiconductor equipment manufacturers. The five largest positions in the fund are shown below:

1. Apple: 21.6%
2. Microsoft: 18.6%
3. Nvidia: 6.9%
4. Broadcom: 3.3%
5. Adobe: 2.2%

Readers should be cognizant of the concentration risk. Apple and Microsoft make up 40% of the Vanguard Information Technology ETF, so underperformance in either stock could drag the entire index fund down. That said, the Vanguard Information Technology ETF returned 511% over the last decade, more than double what the S&P 500 returned.

The last item of note are fees associated with the index fund. The Vanguard Information Technology ETF has a below-average expense ratio of 0.1%, meaning a $5,000 portfolio would entail $5 in fees per year.

Ultimately, this index fund is a good option for investors who want more exposure to technology stocks, but there is one giant exception. Investors who already have sizable stakes in Apple or Microsoft should probably steer clear of the Vanguard Information Technology ETF.

2. Buy an S&P 500 index fund and technology stocks

There is another index-fund-based strategy investors should consider. Rather than owning a technology-focused index fund, technology bulls can buy an S&P 500 index fund and supplement it with individual technology stocks.

That strategy limits downside risk by anchoring returns to the S&P 500, which has never failed to produce a positive return over any rolling 20-year period in history. But the strategy also leaves room for upside if the supplemental technology stocks beat the S&P 500.