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The Best 401(k) Funds from Vanguard

A breakdown of mutual funds for long-term growth investors

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Watching your 401(k) balance in 2011 was a roller coaster ride. You probably saw it go up for a while at the beginning of the year, then take a steep dive down, then rise again before the year closed out.

Scanning the performance of Vanguard’s funds over the past year, you can understand the argument against mutual funds that invest in stocks. Of Vanguard’s open-end funds, Vanguard Long-Term Treasury (MUTF:VUSTX) was the best performer, returning an astounding 29.3% for 2011. Meanwhile, the Vanguard 500 Index fund (MUTF:VFINX) gained only 2%, and Vanguard Total Stock Market (MUTF:VTSAX) barely managed a 1% return.

You can be sure more volatility is in store for 2012. So, does that mean you should cash in your 401(k) and run for the hills — or at least plow your cash into other low-risk investments like U.S. Treasuries instead of stock funds?

No way!

I am steering investors into stock funds as part of their 401(k) holdings, and Vanguard has some of the best in the business. With more than 170 funds — which I cover every year in my annual Independent Guide to the Vanguard Funds — Vanguard has an almost overwhelming array of options. But I’d like to make that job easier for you by telling you up-front about the best Vanguard funds for your 401(k).

Strengthen Your Core with PRIMECAP or Wellington

Retirement accounts such as 401(k)s are inherently geared toward the long term. But good retirement planning doesn’t just mean saving money — it means making your portfolio grow. Even after you retire at 60 or 65, you could live another 30 years. Put another way, you could be spending almost one-third of your life in retirement. If your money doesn’t grow with your age, you could outlive it. That’s why my first choice among Vanguard funds for your 401(k) is a trio run by PRIMECAP Management: PRIMECAP (MUTF:VPMCX), PRIMECAP Core (MUTF:VPCCX) and Capital Opportunity (MUTF:VHCOX).

The problem is, outside of established 401(k) plans, these funds are closed to most new investors. But if they’re available to you, don’t hesitate to allocate a big chunk of your portfolio to them. The PRIMECAP team is a master of investing for “growth at a reasonable price,” or GARP. Their funds are the largest single component of my retirement and nonretirement accounts, as well as those of my wife and kids.

If the PRIMECAP funds aren’t an option, Vanguard Wellington (MUTF:VWELX) is your next best bet for a solid portfolio core. This fund is the industry’s original balanced fund, putting up strong returns since its inception in 1929 with a portfolio split between about 60% to 70% in high-quality blue-chip stocks, and 30% to 40% in investment-grade government and corporate bonds. This fund alone could easily give you all the bond exposure you need. And in 2011, Wellington’s balanced approach paid off, with a healthy return of 3.9% vs. only 2% for the S&P 500.

The best part about Wellington is its fantastic management team. Ed Bousa took the lead for the fund’s equity portfolio in 2003 with nary a change in the fund’s strong and consistent gait, and very minor changes to the underlying portfolio. Buying only about 100 stocks, he gives shareholders his best ideas — undiluted. Meanwhile, John Keogh handles the fixed-income investments.

Bonus: By investing through your 401(k), you can avoid the $3,000 minimum initial investment required for IRAs and taxable accounts.

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