Better Financial Sector ETF: Vanguard's VFH vs. State Street's XLF

The State Street Financial Select Sector SPDR ETF (NYSEMKT:XLF) provides concentrated, large-cap exposure to the S&P 500 financials, while the Vanguard Financials ETF (NYSEMKT:VFH) offers a broader portfolio including smaller-cap companies.

Investors seeking exposure to the American financial system often weigh these two options for their core sector allocation. While both funds capture the performance of banks, insurers, and capital markets firms, their underlying index methodologies create different risk profiles.

The State Street fund focuses on top-tier giants, whereas the Vanguard fund reaches deeper into the industry for broader diversification.

Snapshot (cost & size)

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

Cost is a negligible differentiator here, though the State Street fund is slightly more affordable with an expense ratio of 0.08% versus 0.09% for the Vanguard fund. For an investor with $10,000, this represents a difference of only $1 per year. Both ETFs currently offer a matching 1.50% dividend yield.

Performance & risk comparison

What's inside

The State Street Financial Select Sector SPDR ETF targets the financial sector of the S&P 500, focusing on 76 holdings. This concentrated approach includes exposure to banks, real estate investment trusts, consumer finance, and large-scale insurance providers. Its largest positions include Berkshire Hathaway at 11.99%, JPMorgan Chase & Co at 11.07%, and Visa at 7.56%.

The portfolio consists of 98% financial services and 2% technology. Launched in 1998, the State Street fund has a trailing-12-month dividend of $0.79 per share and its price has moved between $47.67 and $56.52 over the past year.

In contrast, the Vanguard Financials ETF uses a broader strategy to track 404 holdings, reaching further down the market-cap scale than its State Street counterpart. Its top positions include JPMorgan Chase at 9.52%, Berkshire Hathaway at 7.73%, and Mastercard at 5.05%.

The sector allocation is 97% financial services, 2% technology, and 1% real estate. Launched in 2004, the Vanguard fund has a trailing-12-month dividend of $1.94 per share. Its shares have traded within a 52-week range of $116.67 and $137.89. The fund uses a full-replication strategy when possible to track its benchmark accurately.

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What this means for investors

For investors seeking an ETF focused on the financial sector of the stock market, the State Street Financial Select Sector SPDR ETF (XLF) and the Vanguard Financials ETF (VFH) meet this need, but use different strategies to deliver returns. Given their similar expense ratios and identical dividend yields, choosing between the pair comes down to which better meets an individual investor’s objectives.

XLF focuses on the financial stocks within the S&P 500, which means the fund’s performance relies on these large-cap holdings. Berkshire Hathaway and JPMorgan Chase alone comprise over 20% of the fund. This approach led to a lower one-year return although the ETF sports a much larger AUM compared to VFH, delivering greater liquidity for active traders.

VFH offers a far more diversified set of over 400 holdings. This strategy gives you exposure to a wide range of financial companies, including mid and small-cap stocks. As a result, performance doesn’t rely on a handful of businesses, which helped the ETF deliver a stronger one-year return. However, smaller institutions come with greater risk than large, established financial institutions. In fact, Vanguard classifies VFH as a risk level five, the highest level of risk it offers.

As a result, VFH is for investors who want broad exposure to the financial sector in exchange for greater volatility and risk, while XLF is better for conservative investors who want to stick to the big players in the industry.

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