Could This Growth ETF Outperform the Market by 25% in 5 Years?

When looking several years into the future at high growth investment themes, it often makes sense to target the strategy itself instead of trying to pick individual winners.

That makes choosing a growth ETF the better choice. Their built-in combination of diversification, fundamentals-based strategies, and low fees makes investing easy and efficient. There are a number of high quality growth funds to choose from, but one in particular stands out as a great candidate to outperform the market over the next half decade: the Schwab U.S. Large-Cap Growth ETF (NYSEMKT: SCHG).

In my view, SCHG has a reasonable path to outperforming the S&P 500 by roughly 25% over the next five years, but it likely needs a few factors to work in its favor. Outperformance isn't a guarantee, but it is a sensible base case if conditions line up.

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What is the Schwab U.S. Large-Cap Growth ETF?

SCHG tracks the Dow Jones U.S. Large-Cap Growth Total Stock Market index and holds more than 200 U.S. stocks. These are companies selected for characteristics like higher expected earnings and revenue growth compared to the overall market.

This ETF tends to target companies that reinvest aggressively back into the business, are able to expand globally, and benefit from long-term trends, such as software adoption, digital commerce, cloud infrastructure, and innovative technology.

The tech and communication services sectors, not surprisingly, play a big role in the portfolio, but SCHG also owns growth-oriented names from the healthcare, consumer discretionary, and industrialssectors. That breadth matters because the next leg of growth leadership is unlikely to come from just a handful of mega-cap names.

SCHG also charges an expense ratio of just 0.04%, making it one of the cheapest options available in this space. To achieve significant outperformance, you need as little fee drag as possible. The Schwab U.S. Large-Cap Growth ETF checks that box.

Why the next five years could favor this ETF

To achieve 25% outperformance, SCHG would need to beat the S&P 500 by roughly 5% annually. For example, if the S&P 500 returns 8% per year, SCHG would need to return about 13%. What would need to happen for that to occur?

First, earnings growth needs to be sustainable. Over long periods, stock returns ultimately track earnings growth. Large-cap growth companies should grow faster than the average company. In theory, that should lead to outperformance.

Second, market leadership needs to broaden. The last few years have been dominated by a small group of mega-cap tech companies. If capital spending on artificial intelligence (AI), software, and automation spreads across a wider ecosystem, SCHG benefits because it owns many of those "second-in-line" beneficiaries.

Third, interest rates probably need to keep drifting lower. Growth stocks don't necessarily need ultra-low rates to perform well, but it can really help. And they often struggle when rates rise quickly.

These aren't aggressive assumptions, but they do require a continuation of the current economic expansion and a few macro elements to work in their favor.

The risks I would not ignore

The biggest risk is that growth stocks have already led the market for years and are fairly richly valued. That trend would obviously need to continue.

If valuations contract, SCHG could lag even if fundamentals remain strong. If inflation reaccelerates and forces rates higher, growth stocks could underperform like they did in 2022.

Given current economic uncertainties, such as a labor market slowdown or consumer affordability issues, this trade probably needs some time to play out. Five years should be enough time to ride out shorter-term risks.

Why SCHG is a solid core growth holding

What I like about SCHG is that it uses a smart, logical strategy and charges minimal fees to do so. If growth stocks can maintain momentum and the global economy can manage a soft landing, SCHG has a realistic chance to beat the S&P 500 by about 25% over the next five years.

David Dierking has positions in Schwab Strategic Trust-Schwab U.s. Large-Cap Growth ETF. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.