Wall Street’s “smart money” has really been making a case for some of the market’s best index funds.
Months ago, Warren Buffett drew headlines for saying the money he plans to leave behind for his wife should be mostly sunk into a low-cost S&P 500 index fund. (For the record, he prefers Vanguard’s offerings, which likely means the VOO ETF.) More recently, Charles Schwab’s (SCHW) namesake founder said that index funds were right for 98% of Americans. (You’ll be surprised to find that Chuck gave a mention to Schwab’s “1000 Index.”)
And it’s pretty hard to argue with them.
After all, index funds can offer portfolio stability in a pinch, meaning even the most novice investor can do right just by stocking up on a few of the best index funds the market has to offer. Whether it’s an index-tracking mutual fund in your 401k, or a few ETFs in your IRA, you can throw together hundreds of stocks, some commodities, bonds — you name it! — into your retirement plan without breaking a sweat or dropping thousands of dollars in trading fees.
Which funds to buy ultimately is up to you — your investment horizons, your risk tolerance. But if you’re looking for a place to start, consider this list of seven of the best index funds that will tackle most of the globe, and will position you in both growth and income.
Best Index Funds – Vanguard S&P 500 ETF (VOO)
The brightest minds on Wall Street have a nagging problem — they can’t beat the market. Hedge funds have been underperforming the S&P 500 for years on end. More often than not, mutual funds can’t get over the hump, either.
Sounds like the market is a pretty formidable investment, then, huh?
It is. Including dividends, the S&P 500 has returned 9.45% annually over the past 20 years — an amount that puts the vast majority of fixed income to shame.
What’s great is that investing in the S&P 500 couldn’t be easier — or cheaper. The SPDR S&P 500 ETF (SPY), iShares Core S&P 500 ETF (IVV) and Vanguard S&P 500 ETF (VOO) all allow you to “track” the S&P 500 — that means positions in Apple (AAPL), Exxon Mobil (XOM) and the rest of the gang. You not only get access to the capital gains of the group, but also just less than 2% in dividends at current prices.
And all three funds provide this for less than a dollar for every $1,000 invested.
So why the VOO over the IVV and SPY ETFs? More principle than anything else. Investing in an S&P 500 is truly one of the cheapest ways to diversify your holdings in a hurry. So if all else is equal (which it is — all three funds all simply track the S&P 500), why not go with the one with the lowest total expenses?
And at 0.05%, VOO takes the pricing gold.
Best Index Funds – iShares Core S&P Small-Cap ETF (IJR)
The S&P 500 is great because it’s a host of large-cap stocks that offer some stability, some dividends and decent growth. That’s why you’ll want to add small-cap stocks to supercharge your growth.
Small-cap stocks are naturally riskier than their larger counterparts. Many of them are newer businesses that aren’t necessarily as battle-tested as the blue chips. Adding to the risk is the fact that their financial resources are simply smaller — debt’s harder to come by, and cash usually is spent growing the business rather than sitting in a vault for a rainy day.
On the flip side, though, it’s a heck of a lot easier to double revenues when you’re a $1 billion company than when you’re a $100 billion company. And financial growth more often than not begets stock growth, meaning that when small-caps charge ahead, the gains can be outstanding.
One of the best index funds to harness these fiery upstarts is the iShares Core S&P Small Cap ETF (IJR). This ETF holds 602 small-cap stocks including biotech stock Questcor Pharmaceuticals (QCOR) and IT shop Arris Group (ARRS) — a pair of companies that have more than doubled in the past year.
While there are a number of small-cap funds out there, IJR has boasted some of the best returns on a consistent basis, and Morningstar rates it four stars — better than the iShares Russell 2000 ETF (IWM), which tracks the most popular small-cap index, the Russell 2000. IJR also features a low expense ratio of 0.17%.
Best Index Funds – Vanguard FTSE Developed Markets ETF (VEA)
You’ve got the U.S. pretty well taken care of between VOO and IJR. Next up — the world.
The Vanguard FTSE Developed Markets ETF (VEA) is one of the best index funds for tapping into the developed markets of Europe and Asia.
If you’re new to the term, the quick-and-dirty explanation of “developed market” is simply a country with advanced economies with higher incomes and regulated markets. The U.S., for instance, is a developed market. Kazakhstan, while an Olympic boxing powerhouse, is not a developed market.
The VEA is much like the SPY in that you’re being offered stable, blue-chip businesses that even throw off nearly 3% in dividends every year. The biggest difference is that these firms are headquartered in big European or Asian countries, but even then, many of these businesses are highly international in nature. Top holdings include Royal Dutch Shell (RDS.A, RDS.B), Nestle (NSRGY), Toyota (TM) — they’re based in Netherlands, Switzerland and Japan, but all selling products right in your back yard.
Best Index Funds – iShares MSCI Emerging Markets ETF (EEM)
Just as you want to find stability and growth by pairing large caps with small caps, so should you find stability in developed markets and growth in emerging markets (EMs).
The term “emerging” refers to the higher growth but relatively lower amount of stability in up-and-coming markets. The thought is that you have countries with burgeoning populations, escalating middle classes with more spending power, but the incomes aren’t yet up to par with higher-income countries — they’re closing the gap, though, which bodes well for the companies in those markets.
The banner EM countries are the “BRICs” — Brazil, Russia, India and, of course, China — but also include countries such as South Africa, South Korea and even Mexico.
The iShares MSCI Emerging Markets ETF (EEM) is the most ubiquitous of the emerging-market ETFs, holding 800-plus EM companies. And don’t let the “emerging” moniker fool you — there are some serious players in the EEM ETF. For instance, there’s a good chance you have either a Samsung (SSNLF) Galaxy smartphone, or maybe one of the company’s appliances in your home. You’ve probably never heard of Taiwan Semiconductor (TSM), but you’ll be using its products if you buy an iPhone 6 or iPad Air 2 this year.
Best Index Funds – Global X Next Emerging & Frontier ETF (EMFM)
Most of the funds in this article are widely considered to be among the best index funds in their group, and have been for a while. The Global X Next Emerging & Frontier ETF (EMFM) isn’t nearly as established (it launched in late 2013), but it’s a personal favorite of mine because it offers a great combination of the growthier side of the world.
You see, while the aforementioned BRICs are considered “emerging” markets by many, their economic growth has slowed in recent years. Thus, investors looking for the greatest international growth potential are starting to move into other less-ballyhooed emerging markets, and even “frontier markets” — riskier but more rapidly growing than even their EM counterparts.
EMFM caters to those investors, shunning the likes of China and Russia to offer heavier exposure to countries such as Malaysia, Mexico, Indonesia, Turkey and our boxing buddy, Kazakhstan.
Is EMFM a substitute for EEM? Yes and no. If you’re looking for one single place to get “emerging” growth, then you’re certainly choosing between the two. However, the two funds do provide very different global exposure, so investing in both isn’t necessarily a bad way to use your money.
Best Index Funds – Vanguard Total Bond Market ETF (BND)
There are scores of different bond flavors — Treasuries, munis, corporate investment-grade debt, junk — with varying amounts of safety and yield. But at their most base level, most people invest in bonds for the interest income.
Vanguard Total Bond Market ETF (BND) invests in a wide swath of these bonds (though it’s heaviest in Treasuries) with a broad range of maturities to provide investors with a relatively stable investment that offers a modest yield.
As of right now, BND provides an SEC yield of 2.1% — nothing to scream about, but that’s fine. The important thing to note about BND and other modestly yielding debt investments is that you’re not necessarily trying to grow money — just preserve it. That’s not necessarily important to do when you’re younger, but when you have fewer years until retirement, it’s good to start locking down some of your money and collecting interest.
Note: If you’ve noticed a few Vanguard funds, there’s a reason — Vanguard is the low-cost king of funds, be they mutual or exchange-traded. BND is among the best index funds you can get on the cheap, at just 0.08% in expenses.
Best Index Funds – iShares U.S. Preferred Stock ETF (PFF)
However, there is one fantastic source of not just stable income, but substantial, stable income: preferred stocks.
If you want a primer, you can check out my gush-fest on preferred stocks here. But in short, preferred stocks are often referred to as a “hybrid” security because they feature some traits of stocks (they represent equity, you can buy them on exchanges), and some of bonds (they pay a fixed dividend, and they don’t have any voting rights).
Also like bonds, you invest in preferred stocks for the income – and boy, do they throw off a lot of it.
The largest preferred-stock ETF out there, the iShares U.S. Preferred Stock ETF (PFF), boasts a fantastic yield of 6.5% for just 0.48% in fund expenses. It holds more than 300 preferred stocks, most of them representing companies in the financial, real estate and insurance sectors.
You won’t get rich overnight investing in PFF, but reinvesting 6% in dividends every year and sitting back while compounding does its thing will give you a sizable pot of money at the end of the rainbow. Or, if you’re already near retirement, the monthly dividend payout makes a great source of regular income.
Kyle Woodley is the Deputy Managing Editor of InvestorPlace.com. As of this writing, he was long PFF and VOO and may initiate a position in EMFM within the next 30 days. Follow him on Twitter at @KyleWoodley.