The 5 Best Vanguard Funds for Your 401k

Your 401k and your IRA are your best bets for retirement because all your gains compound upon themselves, tax-deferred, until you start taking money out down the road.

VanguardThat’s why I like to put growth investments in my retirement accounts rather than the standard advice to shelter income from bond funds here instead — that’s what municipal bonds are for. Buying a bond fund in a retirement account might shelter that income from taxes, but overall growth is bound to disappoint.

I examine the whole world of Vanguard funds in my service, the Independent Adviser for Vanguard Investors. And for my money’s worth, these are the best Vanguard funds to focus a retirement account around. (And by the way, I own all of these funds in my retirement and my taxable accounts.)

Best Vanguard Funds for Your 401k: Vanguard Health Care (VGHCX)

Top Holdings: Bristol-Myers Squibb Co (NYSE:BMY), Actavis plc (NYSE:ACT), UnitedHealth Group Inc. (NYSE:UNH)
Expense Ratio: 0.35% ($35 annually for every $10,000 invested)

I can’t think of a single “industry” that one could focus on for long-term growth that would be better than healthcare; healthcare was the top performing sector over the past three years. However, you want to have an active manager running your healthcare investments, not an indexer.

I’ve considered Vanguard Health Care (MUTF:VGHCX) among the best Vanguard funds for decades. Investors who’ve heeded my almost constant recommendations to buy Vanguard Health Care have been amply rewarded despite worries about generics manufacturers, government intervention, patent expirations and consumer backlash against drug-makers and health reform.

The real key to this fund’s success in all markets is diversification, investing in five major areas of the health industry, from biotech and pharmaceuticals to managed care and services and health care technology. Plus, a commitment to investing overseas (about 20% of assets, currently) helps.

Check this fund’s risk versus the market or other sector funds, and you’ll see why the health sector is a good diversifier, particularly in sickly markets.

Best Vanguard Funds for Your 401k: Vanguard Dividend Growth (VDIGX)

Top Holdings: UnitedHealth Group Inc., TJX Companies Inc (NYSE:TJX), United Parcel Service, Inc. (NYSE:UPS)
Expense Ratio: 0.31%

While Vanguard Dividend Growth (MUTF:VDIGX) has been around since 1992, the record really begins in February 2006 when classic growth-and-income value manager Donald Kilbride took the helm.

Kilbride’s goal is to create a portfolio that will produce a steady and growing stream of dividends, not necessarily a high current dividend yield. He looks for companies that have what I call “battleship balance sheets” and managements with both the ability and the willingness to not only pay but also to increase the dividend over time.

VDIGX is concentrated, with about 50 holdings, and between 25% and 30% of assets are in his 10 favorites. This is a great fund that could easily serve as your core equity holding. During the 2007-09 credit crisis, the fund fell a relatively shallow 38%, one of the smallest among all Vanguard’s stock funds and a heck of a lot less than index stalwart Vanguard 500 Index’s (MUTF:VFINX) 51% decline.

For a full-cycle market-beater, VDIGX is one of the best Vanguard funds.

Best Vanguard Funds for Your 401k: Vanguard International Growth (VWIGX)

Top Holdings: Tencent Holdings ADR (OTCMKTS:TCEHY), AIA Group Ltd. (OTCMKTS:AAIGF), Baidu Inc (ADR) (NASDAQ:BIDU)
Expense Ratio: 0.47%

Investors seem to have given up on foreign stocks after years of underperformance. That’s a mistake that can be rectified by putting a slug of your retirement money into Vanguard International Growth (MUTF:VWIGX). Markets are cyclical and while U.S. markets have outperformed foreign markets since 2007, the story was reversed in the prior five years.

VWIGX is one of the few multi-managed funds at Vanguard that beats its benchmark consistently. For a fund with three management teams, you still get a fairly concentrated portfolio of about 175 stocks including a double-digit allocation to emerging markets.

Best Vanguard Funds for Your 401k: Vanguard High-Yield Corporate Bond (VWEHX)

Top Holdings: Intelsat 7.25%, U.S. Treasury 0.375%, U.S. Treasury 0.875%
Expense Ratio: 0.23%

The high-yield bond market was hit by the fallout from the rapid decline in oil prices in the second half of the year as investors questioned the ability of some leveraged energy-related companies to pay off their debts. The turmoil created by low oil prices also created better values.

Vanguard High-Yield Corporate’s (MUTF:VWEHX) 4.99% SEC yield (as of the end of January) isn’t sumptuous, but it’s a big improvement from the all-time month-end low of 3.85% hit in June of last year, and it still is a nice pick-up over the 1.78% yield on Vanguard Total Bond Market (MUTF:VBMFX). High-yield bonds are linked to the economy more than they are to changes in interest rates. If the U.S. economy continues to plough a growth course, high-yield bonds should continue to perform well as defaults remain low.

VWEHX is managed by Michael Hong of Wellington. Hong’s conservative approach to the junk bond space has served investors well over the full credit cycle. Expect the fund to lag when high-yield bonds are running but it should perform relatively well when the high-yield bond market comes under pressure — as it has in the past.

Best Vanguard Funds for Your 401k: Vanguard PrimeCap (VPMCX)*

Top Holdings: Biogen Idec Inc (NASDAQ:BIIB), Amgen, Inc. (NASDAQ:AMGN), Eli Lilly and Co (NYSE:LLY)
Expense Ratio: 0.44%

The PrimeCap Management team is among the best in the business — not just in Vanguard’s stable. Its growth-at-a-reasonable-price, or GARP, approach has the managers searching for triple-play companies that can grow earnings at a better-than-market rate, can be more profitable, and can be purchased at the right price.

Unlike most growth managers, they refuse to pay high prices for those companies’ stocks. So they wait. Also unlike other growth managers who constantly turn over their portfolios looking for growth, the PrimeCap team is patient, often holding stocks for years and years. The team is fairly unique as each manager takes a slice of the portfolio and invests as he sees fit. Although there is no collaboration on holdings, per se, several managers may find value in the same stocks.

The resulting portfolio often looks nothing like the broader stock market. Vanguard PrimeCap (MUTF:VPMCX) typically holds 130 stocks or so, with the top 10 positions soaking up over a third of the assets. Healthcare and technology play a big role in the portfolio — combined, the two sectors account for nearly two-thirds of the portfolio.

*Vanguard PrimeCap is closed to new investors, but the team and strategy can be accessed through PrimeCap Odyssey Growth (MUTF:POGRX).

Editor Dan Wiener and Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors, an award-winning monthly advisory letter that keeps subscribers abreast of recent developments at Vanguard, and provides long-term guidance for investing in the Vanguard fund family.

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