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The Best 401(k) Funds from Vanguard

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.

Mid-Caps Are the Sweet Spot

Now that you have a strong core, you’ll want to put about 40% of your 401(k) money into mid-cap funds. My favorite for this role at Vanguard is Vanguard Selected Value (MUTF:VASVX) fund. The fund’s primary managers, Jim Barrow and Mark Giambrone, are quintessential value guys looking for stocks selling below the market’s multiples and yet generating a decent yield. Barrow always has said he’s happy being paid a dividend while waiting for his companies’ shares to take off. And Barrow has a good chunk of his own dough in Selected Value, a nice vote of confidence.

If your plan doesn’t hold Selected Value, you could ask for it, or use an index duo as an alternative: Vanguard Mid-Cap Growth Index (MUTF:VMGIX) and Vanguard Mid-Cap Value Index (MUTF:VMVIX).

Why not just buy Vanguard Mid-Cap Index (MUTF:VIMSX) instead? Splitting your money between the growth and value funds gives you the flexibility to shift your weighting depending on market conditions.

At the moment, you’d want to overweight the growth side of the ledger. The value index has a hefty weighting to financials, which still are under a regulatory cloud, while the growth index is heavier in tech, which could gain momentum as the economy improves.

Best Vanguard International Funds

In 2011, as the European debt crisis came to the fore, holding international stocks hurt. Every one of Vanguard’s international funds lost money, with the best performer (which diluted its foreign stock stake with hefty domestic holdings) being Total World Stock (MUTF:VTWSX), down 7.9%.

So why hold international stocks at all? In the emerging markets, stock market declines are at odds with economic expansion. And don’t forget, when markets take a tumble, that’s also when good managers find the best values.

Which brings us to my next pair of favorite funds. Vanguard has some stellar choices for international investment, and Vanguard International Growth (MUTF:VWIGX) is one of my favorites. There’s a good chance it’s available in your 401(k).

Overseen by three management teams, International Growth still demonstrates strong concentration with only about 180 stocks and 18% of the portfolio in the top 10. Plus, the managers aren’t afraid to commit money to emerging markets, which you might not find in many broad international funds.

Even so, I still think you’ll want to put some money directly into this next fund: Vanguard Emerging Markets Index (MUTF:VEIEX). Why emerging markets? Globally, these countries are showing increased economic firepower, hungry consumers and the ability to take advantage of newly aggressive importers, exporters, manufacturers and entrepreneurs. Emerging Markets Index will give you access to several of these economies, including one of the most powerful investment markets out there — China — with about 18% of its assets there.

In addition, Emerging Markets has investments in Brazil (about 15%), Korea (16%) and Taiwan (10%). In the long term, I think these economies offer great growth opportunities and, at current prices, we’re buying in almost 20% cheaper than we could have a year ago.

Short-Term Bonds for Safety

With a balanced fund like Wellington as your core, you really don’t need another bond fund in your 401(k). But otherwise, it’s worth putting about 10% of your 401(k) money in Vanguard Short-Term Investment-Grade Bond Fund (MUTF:VFSTX).

This fund invests at least 80% of its assets in “investment-grade” or better short- and intermediate-term bonds. It makes a great cash substitute for a long-term portfolio. While it lost about 7.6% in the credit crunch of 2008, it completely recovered in only six months. And while the stock market rocked back and forth in 2011, and money market funds had to be subsidized to stay afloat, VFSTX put up a nice 1.9% return with one-third less volatility than the overall bond market.

Vanguard’s Intermediate-Term Investment-Grade Bond Fund (MUTF:VFICX) also is a good choice, but it will be a bit more volatile when interest rates begin to rise. That said, over the long haul, intermediate-term bonds tend to provide 80% of long bonds’ total return with about half the risk.

Connecting the Dots

Whether you use PRIMECAP (best option) or Wellington (a strong alternative) as your core, you’ll be in good hands with some of the best institutional investors in the business. Round out your equity holdings with either Selected Value, or a combination of Vanguard Mid-Cap Growth Index and Vanguard Mid-Cap Value Index, adjusting your weightings as market conditions warrant.

From there, head overseas with about 10% to 15% in International Growth and Emerging Markets.

Finally, put 10% of your 401(k) money in Vanguard Short-Term Investment-Grade Bond Fund or Vanguard Intermediate-Term Investment-Grade Bond Fund. Remember, this is only if your core is pure equity funds. If you’re using a balanced fund like Wellington, which already has a large allocation to bonds, you won’t need additional fixed-income funds.

For specific breakdowns, please see the table below. Even if some of the funds aren’t available to you, you can use it as a guide to building a strong, diversified retirement portfolio.

Remember, it’s your retirement. So make sure your 401(k) plan is designed to help you, not your benefits manager.

Portfolios for Long-Term Growth Investors
Fund Focus Allocation
Using Wellington as your core
Wellington Balanced (60% stock/40% bond) 40%
Mid-Cap Growth Index Stock — mid-cap growth 30%
Mid-Cap Value Index Stock — mid-cap value 15%
International Growth Foreign stock — large 10%
Emerging Markets Index Foreign stock — emerging 5%
TOTAL 100%
Using PRIMECAP-run funds as your core
Capital Opportunity
Stock — Growth at a reasonable price 44%
Selected Value Stock — mid-cap value 25%
International Growth Foreign stock — large 10%
Short-Term Investment-Grade Bond Short corporate bonds 8%
Investment-Grade Bond
Intermediate corporate bonds 8%
Emerging Markets Index Foreign stock — emerging 5%
TOTAL 100%

Dan Wiener is the editor of The Independent Adviser for Vanguard Investors. A five-time winner of the Specialized Information Publishers Foundation Editorial Excellence Award, Wiener is the founder of the Fund Family Shareholder Association and chief executive officer of Adviser Investments, a Newton, Mass., investment advisory firm.

Article printed from InvestorPlace Media, https://investorplace.com/2012/01/best-401k-mutual-funds-from-vanguard/.

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