Vanguard helped lead a passive investing revolution for ordinary investors, and as such, many investors constantly search for the best Vanguard index funds. For long-term investors, index funds have a lot to offer, from lower cost investing to potentially lower risk and reliable gains.
One major advantage to investing in index funds is that they provide natural diversity. Each index fund actually holds several assets, whether they are stocks or bonds, that mirror a particular market benchmark index like the S&P 500 Index, Nasdaq Composite Index or Dow Jones Industrial Average, for examples.
With more diversity, investors get the benefit of portfolios with lower risk than those that might invest in individual stocks or bonds.
Vanguard, a pioneer in the index fund realm, launched its first index fund – the Vanguard 500 Index Fund that tracks the S&P 500 in 1976. Now, Vanguard offers an array of index fund options that can help meet investors’ personal financial needs. They include both index mutual funds and Exchange-Traded Index Funds (ETFs) that can be bought and sold like stocks over an exchange.
How are index funds different from mutual funds?
An index fund has several similarities and differences when compared with a typical actively managed mutual fund.
Like an actively managed mutual fund, an index fund is a collection of investments that are bundled and traded as a single investment. They can hold tens, hundreds or even thousands of stocks or bonds. Both index funds and actively traded mutual funds are considered lower risk investments than investing in an individual stock.
An index fund can easily be passively managed, meaning that it doesn’t require regular investing decisions by a human, or fund manager the way mutual funds often do. Instead, an index fund can be automated to follow a particular index, like the S&P 500 or a specific sector index, in a way that it simply invests in the same securities at the same time the index includes them. In this way, there is no need for hand-selecting stocks or bonds.
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With actively managed mutual funds, management teams or fund managers make decisions on what to invest in. So, the performance of a mutual fund is based more on their decisions, rather than just how stocks in an index perform.
Some investors prefer actively managed mutual funds because they want to try to make more gains than the broader indices by relying on investing expertise from fund managers. While they could indeed beat the market benchmarks, mutual fund investors also face another key difference between index funds and mutual funds – generally higher fees.
As you might guess, if you are trying to score better returns than the market, you’ll have to hire an expert to help. And that expertise costs money in the form of management fees and commissions.
In that regard, actively managed funds may be better for investors willing to take on more risk for more reward, while index funds may be preferable for those looking for lower-risk assets in exchange for reliability and lower cost.
What is the difference between index mutual funds and index ETFs?
Typically, mutual funds are bought and sold through financial investing firms like Vanguard. ETFs, on the other hand, offer a way for investors to buy in through shares that trade like stock over a market exchange.
One main advantage with ETFs is that they typically have a lower barrier to entry. With ETFs, you have the option of buying just one share, which could have a very low price, depending on the market value. With mutual funds, you are likely to have to make a minimum flat-fee investment to buy into the fund.
At Vanguard, you can find shares of ETFs ranging from about $50 to a few hundred dollars, although again these prices change according to their market value. However, to invest in the company’s mutual funds, you’ll need to deposit at least $3,000.
On the other hand, one advantage a mutual fund offers is the ability to make automatic investments and withdrawals. With ETFs, you cannot make trades automatically like that.
Both mutual funds and ETFs can make good investment choices for people who want to dive into index investing. The best way to invest depends on your personal situation and preferences.
Best Vanguard Index Funds
Vanguard, among the largest investment companies in the world, has a slate of index funds that have proven to provide reliable returns to investors. In total, it has about 70 index ETFs and 65 index mutual funds.
Of course, every investment carries some degree of risk, and there is no guarantee that these Vanguard index will continue to perform as they have in the past. But past performance is often a good indicator of future performance.
Here are some of the more popular Vanguard Index Fund ETFs that have been among Vanguard’s top-yielding funds in recent years:
Best Vanguard Index Funds: Domestic Stocks
S&P 500 ETF (VOO). This fund is ideal for investors who want a way to invest in the general U.S. stock market. It follows the S&P 500 companies, which include the largest companies in the U.S. such as Apple Inc. (AAPL), Microsoft, Inc. (MSFT), Amazon.com (AMZN), Google parent Alphabet Inc. (GOOG), and Facebook Inc. (FB), among many other large well-known companies.
VOO has provided average annual returns of 14.43% in the past five years, as the stock market has been on a steady bull run. The expense ratio for VOO is 0.03%.
Vanguard Russell 1000 Growth ETF (VONG). For stock investors willing to take on more risk, VONG has the potential to offer higher rewards. It follows larger growth companies in the Russell 1000 Growth Index, which include the likes of Apple (AAPL) and Microsoft, Corp. (MSFT) as well as Tesla, Inc. (TSLA) and Adobe, Inc. (ADBE).
In the past five years, VONG has averaged an annual return of 20.54%, ranking it among Vanguard’s best index funds. VONG’s expense ratio is 0.08%.
Best Vanguard Index Funds: International Stocks
Vanguard Total International Stocks ETF (VXUS). This fund tracks the FTSE Global All Cap ex US Index with 7,425 stocks. It is ideal for investors who want to add exposure to international companies in both developed and emerging markets into their portfolio. VXUS’ largest holdings include companies like China-based Alibaba Group Holdings (BABA) and Tencent Holdings (TCEHY) as well as companies like Taiwan Semiconductor Manufacturing Co. (TSM) and Switzerland’s Nestle (NSRGY).
Since inception in 2011, VXUS has drawn 3.66% in average annual returns. It has an expense ratio of 0.08%, which is considered very low.
Best Vanguard Index Funds: Bonds
Vanguard Extended Duration Treasury ETF (EDV). This fund tracks the Bloomberg Barclays U.S. Treasury STRIPES 20—30 Year Equal Par Bond Index. Essentially, investors get broad exposure to the long-term Treasury STRIPS market as the fund holds 82 U.S. Government bonds. As a bond fund, EDV give investors a way to offset some of the risk of stocks and diversify their portfolio.
Since its inception in 2007, EDV has averaged 9.72% in annual returns. As of December 2019, its expense ratio was 0.07%
Vanguard Long-Term Bond ETF (BLV). The Vanguard Long-Term Bond ETF follows the Bloomberg Barclays U.S. Long Government/Credit Float Adjusted Index. It includes 2,648 bonds.
Like EDV, this fund is one of Vanguard’s best performing bond index funds in terms of performance. It has averaged 7.89% in annual returns since its inception in 2007. BLV’s expense ratio is 0.05%.
Best Vanguard Index Funds: Sector-Specific
Information Technology ETF (VGT). This fund has also been among the best performing Vanguard Index ETFs in terms of returns. It holds 328 stocks that focus on the technology sector by following the MSCI U.S. IMI Info Technology 25/50 benchmark. Some of VGT’s top holdings are Apple. Inc. (AAPL), Microsoft Corp. (MSFT), Visa Inc. (V) and NVIDIA Corp. (NVIDIA).
Since its inception in 2004, it has drawn an average annual return of 12.92%, including a return of 56% in the past year. VGT has an expense ratio of 0.10%.
Consumer Discretionary ETF (VCR). VCR follows major U.S. consumer stocks that benefit from consumers having extra money in their pockets. It tracks the MSCI U.S. IMI ConsDiscretionary 25/50 benchmark, holding 291 stocks along the likes of Amazon.com, Inc. (AMZN), Home Depot, Inc. (HD) Tesla, Inc. (TSLA), McDonald’s Corp. (MCD) and Nike, Inc. (NKE).
In the past five years, VCR has yielded average annual gains of 17.05%. Its expense ratio is 0.10%
Comparable Vanguard Mutual Funds
Of course, Vanguard also offers an array of mutual funds that follow market benchmarks, including many of the same benchmarks that Vanguard Index ETFs follow.
They produce gains generally on par compared to their ETF counterpart. However, as mutual funds, they do have a higher barrier to entry and tend to have higher fees.
Among Vanguard’s Index Mutual Funds:
- Vanguard Long-Term Bond Index Fund Admiral Shares (VBLAX): This fund is comparable to the Vanguard Long-Term Bond ETF (BLV). Its expense ratio is 0.07%, compared to BLV’s 0.05%. Investors must commit a minimum of $3,000, compared to BLV’s recent share price of about $113 as of mid-September 2020.
- Vanguard 500 Index Fund Admiral Shares (VFIAX): This mutual fund tracks the S&P 500 Index of the 500 largest U.S. companies. It is comparable to S&P 500 ETF (VOO).However, its expense ratio is 0.04% compared to VOO’s 0.03%. Investors must commit a minimum of $3,000, compared to VOO’s recent share price near $308.
- Vanguard Small-Cap Index Fund Admiral Shares (VSMAX). This fund is comparable to Vanguard Small-Cap ETF (VB), both of which have an expense ratio of 0.05%. Investors must commit a minimum of $3,000, compared to VB’s recent share price near $156.
Which Vanguard Index Fund is the Best?
Each investors’ situation is unique – from their financial goals and risk tolerance to their total assets and budget. So, there is no one-size-fits-all “best” Vanguard Index Fund.
Vanguard has a number of high-performing index funds that offer returns and reliability, as we reviewed above.
Of all of Vanguard’s Index ETFs, the top 20 that have drawn the most gains in the past five years as of August 31, 2020 are:
- Information Technology ETF (VGT): 28.03%
- Mega Cap Growth ETF (MGK): 21.05%
- Russell 1000 Growth ETF (VONG): 20.54%
- Growth ETF (VUG): 19.71%
- S&P 500 Growth ETF (VOOG): 18.82%
- Consumer Discretionary ETF (VCR): 17.05%
- Mega Cap ETF (MGC): 15.61%
- Large-Cap EF (VV): 14.65%
- S&P 500 ETF (VOO): 14.43%
- Mid-Cap Growth ETF (VOT): 13.44%
- Russell 1000 ETF (VONE): 14.17%
- Dividend Appreciation ETF (VIG): 13.89%
- Total Stock Market ETF (VTI): 13.84%
- Russell 3000 ETF (VTHR): 13.70%
- Small Cap Growth ETF (VBK): 12.76%
- Health Care ETF (VHT) 11.21%
- Extended Duration Treasury ETF (EDV): 10.96%
- Extended Market ETF (VXF): 10.86%
- Utilities ETF (VPU): 10.9%
- Russell 2000 Growth ETF (VTWG): 10.51%
Remember, just because an index fund has yielded high returns doesn’t necessarily mean it is the “best” index fund. The best index fund is the one that fits into your overall portfolio plan, including being a match with your risk tolerance and investing goals.
What to know about fees and other costs
When it comes to investing decisions, you have more to consider than just what kind of growth you can expect from your investments. You also need to consider the costs associated with your investing choices, including fees for managing your assets and any tax implications.
Vanguard says the expense ratio across its index mutual funds and ETFs is “83% less than the industry average.”
Index fund investing can bring a lower tax bill than investing in actively managed mutual funds. That’s because with index fund investing, the number of trades is typically smaller because the holdings simply mirror the broader market benchmark, which tend not to change often. Actively managed funds may have more trades as managers try to go after higher gains and shift securities in and out of the fund depending on how they expect them to perform.
The rise of index investing
Investing in index funds has become an increasingly popular strategy in recent years, especially as the overall stock market has been on a run for the past decade. Vanguard says it has $3 trillion invested with its Vanguard Index Funds and ETFs.
More investors are seeing the value of putting their money into passively managed funds, where they can save a substantial amount of money over more expensive actively managed funds. After all, fees can compound over the years into significant costs that eat into returns.
How to build a portfolio using index funds
If you’re considering how to build a portfolio using the Vanguard index funds, you might consider the three-fund portfolio. Vanguard enthusiasts (sometimes referred to as Bogleheads after the Vanguard founder Jack Bogle) often discuss utilizing a three-fund portfolio.
The three-fund portfolio approach is simple. It seeks adequate returns using low-cost index funds while achieving sufficient diversification and a balanced portfolio. Often times, this simple three-fund portfolio that any retail investor can build will outperform professionally constructed portfolios using fancy vehicles and funds.
The three-fund portfolio uses three index funds to give exposure to domestic equities, international equities and bonds.
Vanguard index funds make this super easy to accomplish. While your construction might vary, typically Bogleheads will opt for the total stock market index funds over something a little more narrow such as the S&P 500 index fund. As such, typically the three-fund portfolio using the best Vanguard index funds would look like the following:
- Vanguard Total Stock Market ETF (VTI)
- Vanguard Total International Stocks ETF (VXUS)
- Vanguard Total Bond Market Index (BND)
But how much do you allocate to each index fund? A common approach is to first determine your split between equities and bonds, then determine what portion of the equities allocation is allocated to domestic and how much is allocated to international. A common rule of thumb is to allocate 30% of your equities portion to international (but you can adjust as it fits your personal tastes). If you’re unsure of what stocks/bonds asset allocation to consider, review the Vanguard portfolio allocation data as it can be extremely helpful.
So, if you opt for a 70/30 stocks/bonds split and you’re assuming 30% of your equities going into international, here’s what you would be looking at:
- 70% Equities broken down into 70% Total Stock Market (VTI) and 30% International (VXUS)
- 30% Bonds: Bond Index (BND)
Doing the math, we get into the specific allocations as follows:
- 49% Total Stock Market (VTI)
- 21% International (VXUS)
- 30% Bonds: Bond Index (BND)
The bottom line
Index investing has a number of pros and cons for investors to consider. If you’re among the investors who do want to track the broader market, or specific sections of the market, Vanguard has a number of index funds to consider for a variety of needs.
For more guidance finding the right Vanguard Index Fund for you, consider hiring a financial advisor who can review your overall financial picture and specific investing goals.