While companies like Vanguard may have led the low-cost, passive investing revolution over the recent decades, Charles Schwab has quickly caught up and offers comparable offerings to investors seeking a simple portfolio built using the best Schwab index funds. These Schwab index funds offer low fees and diversified holdings. Moreover, portfolios built around simple index funds have shown to outperform the vast majority of active investment managers. For long-term investors, Schwab index funds have a lot to offer.
Index funds are attractive to many investors for a number of reasons. First, the funds provide easy diversity. Index funds essentially mirror a particular market benchmark index – the most common being the S&P 500 Index or the Nasdaq Composite Index. Rather than attempt to hold a diversified basket of companies in your portfolio, buying the index fund essentially accomplishes this for you with ease. By having a diverse portfolio, investors typically have lower risk than if they concentrated invested capital in a handful of stocks or investments.
Charles Schwab & Co. launched its first index fund in the early 90s. It was designed to mirror the Schwab 1000 Index, an index that tracked the performance of America’s largest 1000 companies. In 2009, Schwab launched a suite of ETFs to offer investors more low-cost options for index investing. Over the years, Schwab has beefed up its offerings including things such as target date index funds.
Recently, as of 2017, Schwab has further reduced its costs to fully compete with historical low-cost providers such as Vanguard in the index investing space. Now, Schwab index funds have some of the lowest fees in the industry, and the company has similarly killed off trading commissions. It’s never cost less to invest in funds with your Schwab account.
According to Schwab, the company has over $250 billion in assets invested in index funds and is the third largest provider of index mutual funds.
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What is index investing?
Simply put, index investing is when a mutual fund or ETF contains a portfolio of securities that track a particular index. Index investing is one of the most simple and effective ways to gain exposure to investing returns correlated to the growth of the economy over time. To “invest in an index,” you have to invest in a fund that tracks the index. The index itself isn’t a security or investment product, but is a piece of intellectual property (or a list of companies). To invest in the index, you buy and hold the index fund that attempts to replicate the index as closely as possible.
Since index funds simply replicate the index it follows, it requires less management than an actively managed fund and typically has lower fees which might mean higher long-term gains (due to less fees being taken out over time).
How are index funds different from actively managed funds?
Whether the fund you buy is an index fund or a actively managed fund, it works the same in terms of buying shares of the fund. By buying the shares of the fund, you’re essentially owning the internal components that are inside the fund. The difference in index vs. actively managed mostly comes into play with respect to what is owned in the fund and when the components change.
An index fund simply follows an index. For example, an S&P 500 index fund owns the companies that makes up the S&P 500. Most of them are “market-cap” weighted index funds similar to how the S&P 500 index is market-cap weighted. So, the fund’s assets are split according to the weights of the individual companies inside the S&P 500. Apple (AAPL) might make up 5% of the S&P 500 while a company like Target (TGT) might make up 1% of the index. If you own the index fund, you would have a similar split in terms of 5% of the money you have invested in the fund would be allocated to Apple shares.
When companies are removed or added to the index, the fund will make the same changes. The manager of the fund does not decide when to add, remove or change allocations. He or she simply follows the index.
Actively managed funds, of course, are different. These funds don’t follow an index, and instead the investor is relying on the skill and expertise of the fund manager. Typically these funds will have an established strategy which indicates what investments it will typically hold inside the fund, but how the investments move around within that strategy is up to the fund manager. He or she may do extremely well one year and not as well the next year. Typically, actively managed funds have higher fees which would make sense since there is more decision making and research going into the management of the fund.
Of course, data has shown over the years that actively managed funds rarely outperform the passively managed or index funds. Typically, investors pay higher fees for equal or worse performance when owning actively managed funds over index funds.
Lastly, index funds typically have lower internal turnover as compared to actively managed funds which can have a significant benefit with respect to taxation. You can read more about this subject specifically with respect to investing in funds via our article on the tax cost ratio.
Should you own index mutual funds or index ETFs?
A mutual fund that tracks the S&P 500 index should perform the same as an ETF that tracks the S&P 500 index. The differences mostly come in some of the structural parts of how mutual funds differ from ETFs.
First, mutual funds typically have some sort of investment minimum. For instance, you might need to invest $2500 to get started with a mutual fund. ETFs don’t have minimums.
ETFs are more liquid. They trade on the open market very similar to shares of stock, and you can buy and sell them all day during open market hours. When you buy a share of the ETF, you are buying the share from another investor who is selling the share – very similar to how stocks work. However, with mutual funds, you are sending your money to the mutual fund company, buying shares from the company itself. Also mutual funds are traded just once per day. So if you put in the order to buy shares, you usually have to wait until the end of the day for the purchase to go through.
The one advantage I’ve found to index mutual funds compared to index ETFs is that I can set up automatic investments into the mutual fund but I can’t do it with ETFs. For example, if I wanted to setup automatic investing of $1,000 every month in an S&P 500 index fund on my Schwab account, I’d have to do it through the Schwab mutual fund. There’s no way to automatically invest $1,000 every month into an ETF.
Other than, typically if you’re looking for index funds, ETFs make a ton of sense. If you’re looking for a non-index fund, then mutual funds might be the better option.
Best Schwab Index Funds
Schwab offers an incredible array of funds for you to choose from. Since ETFs make a ton of sense for index investing, let’s start with ETFs. Here are some considerations for the best Schwab index funds.
Best Schwab Index Funds: Domestic Stocks
Schwab US Broad Market ETF (SCHB): This ETF is a broad equities fund (broader than the S&P 500) that tracks the Dow Jones US Broad Stock Market Index. The index tracks the 2,500 largest publicly traded companies in the United States. For broad domestic equities exposure, this fund is an ideal candidate as a backbone fund for your portfolio. The expense ratio is .03%. As of October 2020, the ETF had annualized returns of 13.51% since inception (November 2009).
Schwab 1000 Index ETF (SCHK): This ETF is another broad equities fund attempting to track the Schwab 1000 Index which makes up the 1,000 largest publicly traded companies in the United States. This is another great backbone fund if you’re wanting more diversification than the S&P 500. The expense ratio is .05%. As of October 2020, the ETF had annualized returns of 11.69% since inception (October 2017).
Schwab US Large Cap Growth ETF (SCHG): This ETF follows the Dow Jones US Large-Cap Growth Total Stock Market Index. The companies included in this index and fund are essentially the companies labeled as “growth” companies within the Dow Jones US Total Stock Market Index. The holdings are typically 750 of the largest “growth” companies in the index. The expense ratio is .04%. The ETF has annualized returns of 16.28% since inception (December 2009).
Schwab US Large Cap Value ETF (SCHV): This ETF follows the Dow Jones US Large-Cap Value Total Stock Market Index. The companies included in this index and fund are essentially the companies labeled as “value” companies within the Dow Jones US Total Stock Market Index. The holdings are typically 750 of the largest “value” companies in the index. The expense ratio is .04%. The ETF has annualized returns of 9.92% since inception (December 2009).
Value vs. Growth
As you can see in comparing the performance of both the Large Cap Growth (SCHG) and large Cap Value (SCHV) ETFs above, growth has outperformed value by a large margin over the last decade. This lines up with much of the narrative you hear if you follow business and financial news. Growth, headlined by mega cap technology stocks like Apple, Google, Facebook, Amazon, Netflix and more has been leading the market higher for many years.
Will growth keep trouncing value in the years ahead? Maybe. Maybe not. Just because growth has been the better investment for the last ten years, it doesn’t mean it’ll be the best investment for the next ten. If building a portfolio for the long haul, it probably makes sense to own both value and growth. Or just own it all with the Broad Market ETF (SCHB) and keep it simple.
Best Schwab Index Funds: International Stocks
Schwab International Equity ETF (SCHF): This ETF tracks the companies within the FTSE Developed Ex-US Index. The ETF is made up of large and mid-cap companies. The expense ratio is .06%. As of October 2020, the ETF had annualized returns of 4.79% since inception (November 2009).
Schwab Emerging Markets Equity ETF (SCHF): This ETF tracks the companies within the FTSE Emerging Index. The ETF is made up of large and mid-cap companies from emerging markets. The expense ratio is .11%. As of October 2020, the ETF had annualized returns of 2.83% since inception (January 2010).
Best Schwab Index Funds: Bonds / Fixed Income
Schwab US Aggregate Bond (SCHZ): This ETF tracks the the Bloomberg Barclays US Aggregate Bond Index.This index is a benchmark that measures the performance of the US investment grade, taxable bond market. It includes US treasuries, corporate bonds and more. When building a balanced portfolio, SCHZ can be a great option for the cornerstone of your bonds or fixed income portion of the portfolio. The expense ratio is .04%. As of October 2020, the ETF had annualized returns of 3.57% since inception (July 2011).
Schwab Long-Term US Treasury ETF (SCHQ): This ETF tracks the total return of the Bloomberg Barclays US Long Treasury Index. The components are US Treasuries with a maturity of ten years or more. The expense ratio is .05%. As of October 2020, the ETF had annualized returns of 16.47% since inception (October 2019). Note that this ETF has only been in existence about a year as of writing.
Comparable Schwab Mutual Funds
As mentioned previously, Schwab offers a number of index mutual funds as well that can compare to the line up of ETFs described above. The returns are typically about the same as the ETF counterparts but as we mentioned, mutual funds can have different structural elements such as investment minimums.
Schwab Total Stock Market Index Fund (SWTSX): This fund is designed to track the return of the total US stock market as measured by the Dow Jones US Total Stock Market Index. The expense ratio is .03% similar to the broad market ETFs mentioned above. Note that Schwab now has a $1 minimum investment into this fund. The annualized returns over the last decade are 13.5% (similar to what you find with SCHB above). Over the last 15 years, the annualized returns are 9.57% (as of October 2020).
Schwab S&P 500 Index Fund (SWPPX): This fund is designed to track the S&P 500 Index. The expense ratio is an ultra-low .02%. Note that Schwab now has a $1 minimum investment into this fund. The annualized returns over the last decade are 13.68% and 9.47% over the last 15 years (as of October 2020).
Schwab 1000 Index Fund (SNXFX): This fund is designed to track the Schwab 1000 Index which tracks the 1000 largest US companies. The expense ratio is .05%. Note that Schwab now has a $1 minimum investment into this fund. The annualized returns over the last decade are 13.51% and 9.42% over the last 15 years (as of October 2020).
Schwab US Large Cap Growth Index Fund (SWLGX): This fund is designed to track the companies in the Russell 1000 Growth Index. The expense ratio is .035%. Note that Schwab now has a $1 minimum investment into this fund. The fund is fairly new so annualized data isn’t relevant.
Schwab US Large Cap Value Index Fund (SWLVX): This fund is designed to track the Russell 1000 Value Index. The expense ratio is .05%. Note that Schwab now has a $1 minimum investment into this fund. The fund is fairly new so annualized data isn’t relevant.
Schwab International Index Fund (SWISX): This fund is designed to track a benchmark index tracking large, non-US companies. The expense ratio is .06%. Note that Schwab now has a $1 minimum investment into this fund. The annualized returns over the last decade are 4.58% and 4.05% over the last 15 years (as of October 2020).
Schwab US Aggregate Bond Index Fund (SWAGX): This fund is designed to track the Bloomberg Barclays US Aggregate Bond Index (similar to SCHZ). The expense ratio is .04%. Note that Schwab now has a $1 minimum investment into this fund. The fund has averaged 5.03% each year of the last three years (as of October 2020).
Which Schwab ETFs have the best returns?
Here is a list of Schwab ETFs that have the highest return over the last five years ranked from highest on down (as of October 2020):
- Schwab US Large Cap Growth ETF (SCHG): 139% return over 5 years
- Schwab US Large Cap ETF (SCHX): 92% return over 5 years
- Schwab US Broad Market ETF (SCHB): 88% return over 5 years
- Schwab US Dividend Equity ETF (SCHD): 80% return over 5 years
- Schwab Fundamental US Large Company Index ETF (FNDX): 58% return of 5 years
- Schwab US Mid Cap ETF (SCHM): 57% return over 5 years
- Schwab Fundamental US Broad Market Index ETF (FNDB): 56% return over 5 years
- Schwab US Large Cap Value ETF (SCHV): 51% return over 5 years
- Schwab US Small Cap ETF (SCHA): 49% return over 5 years
- Schwab Emerging Markets Equity (SCHE): 48% return over 5 years
How to build a portfolio using index funds
If you’re getting started in investing and need to build a diversified portfolio using Schwab index funds, you might consider the three-fund portfolio. The three-fund portfolio is a popular approach by low-cost, passive investors. It’s been popularized by Vanguard followers over the years, but whether you use Vanguard funds or Schwab funds, it makes no difference (since they follow the same indices typically).
The three-fund portfolio is intentionally simple. It pursues good returns using low-cost index funds with a balanced portfolio and ample diversification. While advisors will often put investors in a dozen or more funds to give the appearance of a sophisticated approach, the three-fund portfolio is simple and often outperforms these other approaches.
The three-fund portfolio has three buckets of exposure: domestic equities, international equities and bonds. You can accomplish each bucket with a low-cost index fund.
Some of the ETFs in our list of best Schwab index funds make the three-fund portfolio very easy to construct. While you can choose which domestic equities ETF you want based on your preferences, typically investors will opt for something more diverse than the S&P 500 index (which only measures the 500 largest companies in the US. For example, the Schwab Broad Market ETF (SCHB) is a good candidate.
The three-fund portfolio using the best Schwab index funds might look as follows:
- Schwab Broad Market ETF (SCHB)
- Schwab International Equity ETF (SCHF)
- Schwab US Aggregate Bond (SCHZ)
So, how much should you allocate to each index fund? What is your split between domestic, international and bonds? This of course gets into asset allocation models. My favorite reference for deciding asset allocation is to start with the Vanguard page that shows data on portfolio allocation models. Use that page to determine if you want to go 80/20, 70/30, etc. Then, you move on to the next step.
The next step is to determine how to split up the equities piece of the portfolio between domestic and international. Many investors go with a 30% rule of thumb where 30% of your equities is international.
If, in step one, you chose a 70/30 stocks/bonds split and you go with the 30% international rule of thumb, your three-fund portfolio would look like this:
- 70% Equities broken down into 70% Schwab Broad Market ETF (SCHB) and 30% International (SCHF)
- 30% Bonds: Schwab US Aggregate Bond (SCHZ)
If you do a couple calculations to get to specific allocation percentages, you’ll get the following:
- 49% Schwab Broad Market ETF (SCHB)
- 21% Schwab International Equity ETF (SCHF)
- 30% Schwab US Aggregate Bond (SCHZ)
How easy is that? Of course, over time, if you want to get more fancy and deviate slightly from the three-fund portfolio and add in some other index funds as we’ve discussed here, that’s perfectly acceptable. This is a great starting point, however, and there’s certainly no need to get any more complicated than this if you prefer simplicity.
Frequently Asked Questions
What is index investing?
Index investing refers to buying index funds or ETFs that replicate a benchmark index. A common example is buying an S&P 500 index fund that replicates the S&P 500 index. Index investing is typically a very low-cost way to get a diversified portfolio of holdings automatically.
Why can’t I invest directly in an index?
You can’t directly buy an index, because an index is not a security or investment product. An index is a piece of intellectual property or a list of companies. To “own the index” you must buy a fund that tracks the index. Thankfully there are funds that track just about every major index in the world of finance.
Can you lose money in an index fund?
Yes, you can lose money in an index fund. An index fund simply tracks the index that it follows which is made up of real companies. For instance, if you own an S&P 500 index fund, you will lose money if the S&P 500 index goes down in value on a given trading day.
Is now a good time to buy index funds?
Index funds are a great component of long-term investing. Because nobody can predict the future – especially the near-term future – it is impossible to know what the best time for buying an index fund is especially if your goal is short-term gains. History has shown that if your investment horizon is many years, then it’s almost always a good time to buy index funds.