The best index funds to own in 2021

2020 was an unusual and difficult year in many respects. A global pandemic led to economic recession and market turmoil, but the stock market rebounded mightily from its March 2020 lows, and investors are rightfully asking where should they put their money in 2021? What are the best index funds to own in 2021?

There are a few ways to look at this question. Should investors stay the course with their standard allocation or should they tilt or shift their allocation slightly based on unique factors we expect in 2021? The answer probably lies somewhere in between, but let’s breakdown the context and try to put some specific recommendations in place with respect to the best index funds for 2021.

Looking back at 2020: Evidence for staying the course

2020 was an insane year. We had a true market crash in March of 2020 due to the coronavirus pandemic sweeping the globe. But stocks quickly bottomed and eclipsed new highs later in the year.

This excerpt from awealthofcommonsense.com says it all:

But 2020 looks like it could go down in history as the worst intra-year drawdown that finished the year with a positive return. And the fact that those gains are now in double-digit territory is not something many (any?) people saw coming. The S&P is now up well over 60% since bottoming in late-March.

In fact, this chart from the same article is one of my favorite stock market charts I’ve seen recently.

The above chart shows almost 100 years of history in the S&P 500 index. The blue bar shows the return for that year on the index, and the orange dot shows the worst intra-year drawdown of that year. There are some important takeaways from this chart:

• The S&P 500 finishes up in way more years than it finished down.
• Despite this fact, almost all years include fairly significant drawdowns.
• 2020 is an extraordinary example of a drawdown over 30% yet finishing positive on the year and potentially finishing with double digit gains. Wow!

There are practical investment principles that can be deduced from these takeaways. Namely, staying the course through volatility will typically lead to successful investing. If you panicked near the lows in March of 2020 and sold out of stocks, you made a significant mistake. Simply holding the course would not only have reversed all of those losses, but ended up with actual gains on the year.

With that in mind, what does this mean for us as we navigate which index funds to own for 2021? Simply put, it could mean that you should own the same index funds you’ve been owning in 2020. And 2019. And 2018. You get the point.

But is that it? Just own index funds every year regardless of what is going on? Well, for some people, yes. For others, maybe we can add a layer of sophistication. Let’s go there next.

Invest based on trends?

It’s dangerous to attempt to identify trends heading into a year and then position investment dollars accordingly. By doing so, you’re making a bet that one company will outperform another, or one sector will outperform another. And by making this bet, you can be right or you can be wrong. Data shows that most investors bet incorrectly and would be better off simply owning the entire market through broad based index funds. By owning total or broad based stock market index funds, you don’t have to know what’s going to outperform next year. You’ll own everything and essentially match market returns on the year. It’s not a bad approach. In fact, it’s a great approach.

But I still like to tilt my portfolio just slightly where I think I might be able to capture some additional upside. I do this with two considerations in mind:

1. I do this knowing that I could be incorrect.
2. If I’m incorrect, I will underperform the market and would have been better off just buying the S&P 500 index or a broad based index.

Because I know this, I make very small tilts. For example, if I typically would be in a 70% stocks and 30% bonds portfolio, and the 70% stocks is broken down into 80% total stock market index fund and 20% international stocks index fund, maybe I take 5% of the 80% of total stock market index fund and allocate it to a sector index that I want slightly higher exposure in. Again, small adjustments where if you’re wrong, you’ll still be just fine.

The 2020 trends. What continues?

In 2020, the stay-at-home, work-from-home (WFH) trend was king for much of the year. With much of the world shutdown or compromised, people did more at home. They fixed up their homes, they watched Netflix (NFLX) at home and they bought Pelotons (PTON) to work out at home.

Additionally, mega-cap and large-cap outperformed (mostly led by mega-cap tech) much of the broader market for much of the year. There were crazy days where the stock market would be up 1-2%, yet 80-90% of the stocks that make up the S&P 500 were negative on the day. Just a few, huge stocks were pushing the market averages higher despite most stocks being in the red.

Interestingly, in November 2020, we saw some changes. Small cap stocks roared back and cyclical and value stocks started outperforming tech and the WFH trade a bit. Why? Well, probably a lot of reasons, but one word in particular likely explains the move the most: vaccine.

Vaccine. One could argue that everything in 2021 comes down to the vaccine. If the larger population is now immune to coronavirus, the economy can open fully. The broader economy can catch up and we won’t just see mega-cap tech leading the way while everything else is left behind. November 2020 saw this essentially begin to materialize. Remember, the stock market looks ahead. Moves today are based on what the collective market believes will in happen moving forward.

Value vs. Growth

Value vs. growth is talked about constantly in investing circles and financial media. It was a hot topic in 2020, again, because of how mega-cap tech (growth) was drastically outperforming value stocks. We can see this clearly by just comparing the 2020 performance of the Schwab U.S. Large-Cap Growth Index Fund (SWLGX) and the Schwab U.S. Large-Cap Value Index Fund (SWLVX).

While both growth and value took a large hit in March, growth took off and vastly outperformed value even when considering the rebound of value late in the year.

The best index funds for 2021

If you believe the vaccine is real, you could argue that tilting a bit towards value heading into 2021 could make sense. The value index fund has a decent percentage allocation in things such as financials and industrials. By owning the value index fund, you’re getting a bit more broader exposure to the general economy. If the vaccine is real, the economy should continue to open up.

Some might argue that this is already priced in, and this might be true. But two things I think justify a small tilt toward value. First, as you can see in the above chart, value still has a ways to go to catch up to growth. Even if growth is always going to outperform value on a regular basis due to this new world of technology eating the rest of the world, there’s still a wide gap to close at least slightly. Second, with the Federal Reserve maintaining ultra-accommodative conditions for the economy, I think positioning your portfolio for economic expansion makes sense.

The caveat to all of this is if the vaccine fails, all of the above might be irrelevant. This is indeed tied to at least some success on the vaccine front (which I believe seems extremely promising based on recent data and headlines).

Small caps are in a similar situation as value. They were crapped on for much of the year and came roaring back at the end of the year. You might consider a small tilt to small caps as well.

To get more specific, perhaps you love tech, but think mega-cap tech has gone up so much and you don’t want to have so much emphasis on mega-cap tech? Taking this further, if you own simple S&P 500 index funds, these mega-cap tech names make up large chunks of these index funds because of how large they are and the fact that these index funds are market-cap weighted funds.

So, can you own smaller tech? You can. A fund such as Invesco S&P SmallCap Information Technology ETF (PSCT) is just that. Small cap tech.

To sum up, here are some index funds for 2021 you might consider a slight tilt toward:

• Schwab U.S. Large-Cap Value Index Fund (SWLVX)
• Schwab Small Cap Index Fund (SWSSX)
• Invesco S&P SmallCap Information Technology ETF (PSCT)

Of course, you definitely should not be allocating the majority of your funds into these index funds. These are just slight tilts. You should have a “backbone” to your portfolio made up of broad based funds, and then you layer in some of these funds as tilts for 2021 if you are so inclined. Let’s look at some examples of how you might do this.

Example #1

In 2020, let’s say I’m young and I have a 100% stocks portfolio. My portfolio was made up of Vanguard funds as follows:

• 50% Vanguard Total Stock Market Index (VTSAX)
• 20% Vanguard Growth Index (VIGAX)
• 20% Vanguard Value Index (VVIAX)
• 10% Vanguard Total International Stock Index (VTIAX)

This is a pretty balanced portfolio. Some might say it’s a little light on international, and it might be a little heavy on large cap. Although the total stock market index means half the portfolio is in a total stock market index which includes mid and small cap stocks. How might we modify this slightly to accommodate a tilt as we discussed? Again, small moves are best, so here’s how I’d modify this while introducing some index funds for 2021:

• 49% Vanguard Total Stock Market Index (VTSAX)
• 17% Vanguard Growth Index (VIGAX)
• 20% Vanguard Value Index (VVIAX)
• 10% Vanguard Total International Stock Index (VTIAX)
• 2% Schwab Small Cap Index Fund (SWSSX)
• 2% Invesco S&P SmallCap Information Technology ETF (PSCT)

Since we already had a value index fund, we didn’t need to add it. To accomplish the tilt we reduced the growth fund by three percentage points. We also reduced the total stock market index by one percentage point. Then added the two small cap funds at 2% each. Simple!

Example #2

Let’s do one more similar example using Fidelity index funds. Let’s say our 2020 portfolio looked as follows (note that this is using the three-fund portfolio model):

• 50% Fidelity Total Market Index Fund (FSKAX)
• 20% Fidelity International Index Fund (FSPSX)
• 30% Fidelity US Bond Index Fund (FXNAX)

To accomplish our tilt, we might modify as follows:

• 48% Fidelity Total Market Index Fund (FSKAX)
• 18% Fidelity International Index Fund (FSPSX)
• 28% Fidelity US Bond Index Fund (FXNAX)
• 2% Fidelity Large Cap Value Index Fund (FLCOX)
• 2% Fidelity Small Cap Index Fund (FSSNX)
• 2% Invesco S&P SmallCap Information Technology ETF (PSCT)

In modifying the portfolio, we took 2% out of each of the three existing funds, and added 2% allocations to each 2021 index fund. We also used the Fidelity equivalents of the value and small cap funds rather than the Schwab funds.

Index funds for your portfolio backbone in 2021 (and every other year)

As we’ve said, the funds we choose for 2021 are small adjustments to the overall portfolio. As such, let’s make sure we have a firm understanding of what we should be doing for the larger portfolio backbone. Below are some excellent index fund options that should make up a majority of your allocation.

S&P 500 Index Funds

Ticker	Name	Expense Ratio	Minimum Required	Type
FXAIX	Fidelity 500 Index Fund	.015%	$0	Mutual Fund
SWPPX	Schwab S&P 500 Index Fund	.02%	$0	Mutual Fund
VFIAX	Vanguard 500 Index Fund	.04%	$3,000	Mutual Fund
VOO	Vanguard S&P 500 ETF	.03%	A single share	ETF
SPY	SPDR S&P 500 ETF Trust	.09%	A single share	ETF
IVV	iShares Core S&P 500 ETF	.03%	A single share	ETF

Total Stock Market Index Funds

Ticker	Name	Expense Ratio	Minimum Required	Type
SWTSX	Schwab Total Stock Market Index Fund	.03%	$0	Mutual Fund
FSKAX	Fidelity Total Market Index Fund	.015%	$0	Mutual Fund
VTSAX	Vanguard Total Stock Market Index Fund	.04%	$3,000	Mutual Fund
VTI	Vanguard Total Stock Market ETF	.03%	A single share	ETF

International Index Funds

Index	Ticker	Fund	Expense Ratio	Minimum
MSCI EAFE	SWISX	Schwab International Index Fund	.06%	$0
MSCI ACWI	FTIHX	Fidelity Total International Fund	.06%	$0
FTSE Global All Cap ex US Index	VTIAX	Vanguard Total International Stock Index Fund	.11%	$3,000
FTSE Global All Cap ex US Index	VXUS	Vanguard Total International Stock ETF	.08%	1 share
FTSE Developed ex US Index	SCHF	Schwab International Equity ETF	.06%	1 share
MSCI Emerging Markets Index	FPADX	Fidelity Emerging Markets Index Fund	.076%	$0
FTSE Emerging Markets All Cap China A Inclusion Index	VEMAX	Vanguard Emerging Markets Stock Index Fund	.14%	$3,000
FTSE Emerging Markets All Cap China A Inclusion Index	VWO	Vanguard FTSE Emerging Markets ETF	.10%	1 share
FTSE Emerging Index	SCHE	Schwab Emerging Markets Equity ETF	.11%	$0