Last year, about 84% of actively managed stock funds underperformed the Standard & Poor’s 500 — the worst performance in a decade.
It’s true that the markets were extremely volatile, especially with the U.S. losing its AAA credit rating and the debt crisis in Europe. Even major hedge fund titans such as John Paulson had terrible returns.
But the lackluster performance of funds is no fluke. Consider that over the past five years, 61% of stock funds underperformed the S&P 500 benchmark.
So for investors, a better approach may be to look at index funds. They generally have low expenses because they require few people to manage the operations — a computer can run an index fund. Index funds are also a great way to track key asset classes without the need to time markets. Even Berkshire Hathaway’s (NYSE:BRK.A, NYSE:BRK.B) Warren Buffett likes index funds.
Here are four index funds that cover major market categories:
iShares Barclays Aggregate Bond
The iShares Barclays Aggregate Bond (NYSE:AGG) exchange-traded fund (ETF) is an easy, cheap way to get exposure to the bond market. The index tracks U.S. investment-grade bonds, such as for mortgages, corporate issues and Treasuries.
Even if there’s a rise in interest rates, the iShares fund should have some protection. Keep in mind that the average duration on the portfolio is about four to five years.
The expense ratio is only 0.22%, and the yield for the past 12 months was 2.81%.
Vanguard Total Stock Market Index
When it comes to index funds, the Vanguard Total Stock Market Index (MUTF:VGENX) is one of the best. It tracks the MSCI U.S. Broad Market Index, which covers most of the stocks in the U.S.
The expense ratio is a rock-bottom 0.05%, and the dividend yield is 1.75%. In fact, over the past decade, the Vanguard Total Stock Market Index has beaten the S&P 500 with an average annual return of 4.59%, versus the S&P’s 3.67%.
Vanguard Emerging Markets Stock Index
Emerging markets — including China, Brazil and India — saw major losses last year. But their long-term potential still looks bright.
Vanguard Emerging Markets Stock Index (MUTF:VEIEX) fund is a good choice to capitalize on this opportunity. It tracks the MSCI Emerging Markets Index, which includes about 900 stocks. The expense ratio is 0.33%, and the dividend yield is 1.87%.
And yes, volatility has been high. Last year, the fund plunged by 18.78%. But the current year’s return is 14.93%
PowerShares DB Commodity Index Tracking
Commodities are an important component for a portfolio. They can be an effective way to help beat inflation — which could be a problem in the next few years — as well as a way to benefit from global growth.
A top ETF in this sector is the PowerShares DB Commodity Index Tracking (NYSE:DBC). It’s based on the Deutsche Bank Liquid Commodity Index, which tracks 14 commodities, including gold, corn, wheat and WTI crude oil.
The expense ratio may seem high at 0.85%, but this is actually fairly reasonable since it can be expensive to operate a fund that invests in complex futures.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli. As of this writing, he did not own a position in any of the aforementioned securities.