VFH vs. XLF: Which Financial ETF Is the Better Buy?

The State Street Financial Select Sector SPDR ETF (NYSEMKT:XLF) and the Vanguard Financials ETF (NYSEMKT:VFH) both focus on financials, but VFH provides significantly broader diversification.

Investors looking for exposure to the financial sector often choose between these two funds. Both ETFs hold major banks, insurers, and payment networks -- but they differ in portfolio depth and concentration.

Snapshot (cost & size)

Beta measures price volatility relative to the S&P 500; beta is calculated from monthly returns over the available fund history (up to five years). The 1-year return represents total return over the trailing 12 months. Dividend yield is the trailing-12-month distribution yield.

XLF is slightly cheaper, with an expense ratio of 0.08% compared with VFH’s 0.09%. However, VFH offers a higher dividend yield of 1.67% -- a quarter of a percentage point higher than XLF’s 1.42%.

Performance & risk comparison

What's inside

Launched in 1998, XLF tracks the Financial Select Sector Index, which holds only the financial companies already inside the S&P 500. The fund holds 76 stocks, including top holdings JPMorgan Chase (NYSE:JPM) at 11.7%, Berkshire Hathaway (NYSE:BRKB) at 11.7%, and Visa (NYSE:V) at 7.6%.

VFH tracks the MSCI US Investable Market Index (IMI)/Financials 25/50 -- a benchmark that goes beyond just the S&P 500 to include mid- and small-cap financial companies. The fund holds 428 stocks, including top holdings JPMorgan Chase at 9.2%, Berkshire Hathaway Inc at 7.8%, and Mastercard Inc (NYSE:MA) at 4.7%. VFH was launched in 2004.

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What this means for investors

Both of these funds are currently trading at or near all-time highs after a strong stretch for financials.

The differences in the number of holdings here matter less than you might think. XLF's 76-stock portfolio and VFH's 428-stock portfolio might sound like very different animals, but both funds’ top 10 position lists include the same companies. VFH’s long tail of additional holdings consists mostly of regional banks, insurers, and fintechs, with fractional weightings. The heavy overlap at the top is the simplest explanation for why five-year returns for these funds have landed in such similar territory.

One other thing worth noting up front: a financial sector ETF is not the same thing as a bank fund. Berkshire Hathaway, Visa, and Mastercard sit near the top of both funds’ portfolios, which means regardless of which fund you choose, a meaningful slice of your money is invested in an insurance-and-industrials conglomerate and two payment networks rather than in lenders.

Here’s where the two funds genuinely differ: VFH's wider net means more exposure to smaller, rate-sensitive regional banks -- the group with the most to gain from a steeper yield curve and the current regulatory environment that has encouraged bank dealmaking, and the group with the most to lose in a credit scare. XLF is the more concentrated bet on the sector’s megacaps.

As for the 0.01 percentage-point difference in fees between these funds, it amounts to about $1 a year on a $10,000 investment. That’s not a deciding factor.

The bottom line: VFH is the better fit for investors who want the full sweep of American finance, including smaller regional banks, while XLF appeals more to those content to let a handful of megacap names do the heavy lifting.

JPMorgan Chase is an advertising partner of Motley Fool Money. Andy Gould has positions in Berkshire Hathaway, Mastercard, and Visa. The Motley Fool has positions in and recommends Berkshire Hathaway, JPMorgan Chase, Mastercard, and Visa. The Motley Fool has a disclosure policy.