Investors that are in their prime earning and compounding years have much different needs than those who need income and capital preservation in retirement. Luckily, both can meet their needs by piling into some of Wall Street’s best index funds.
If you’re in the former crowd, you have one of the single greatest assets on your side — time. Every additional year of saving and compounding is a precious commodity that is critical to long-term success when growing your wealth.
Usually investors under 40 have very specific goals as well. These can include saving for a home, investing for retirement, or growing your child’s college education fund. No matter what your objective may be, having an investment plan in place and monitoring your progress will help ensure you are on the right track.
With that in mind, exchange-traded index funds make a perfect investment vehicle to grow your money. Low-cost index funds can provide transparency, liquidity, tax efficiency and a high degree of diversification for your portfolio.
However, the wide array of ETFs to choose from makes selecting the right index funds daunting. You have to consider costs, asset allocation, security selection and a host of other characteristics.
Fortunately, I have curated a short list of the best index funds with attractive features that investors under 40 should consider.
Best Index Funds: Vanguard Growth ETF (VUG)
Click to Enlarge Dedicating a portion of your portfolio to high-quality, large-cap growth stocks should be a key consideration at this stage of the game.
Vanguard Growth ETF (NYSEARCA:VUG) is one of the best index funds for large-cap growth, consisting of 370 stocks such as Apple Inc. (NASDAQ:AAPL), Google Inc (NASDAQ:GOOGL, NASDAQ:GOOG), and Facebook Inc (NASDAQ:FB).
These companies are focused on growing their top and bottom lines to support new products and innovation for the future. While technology dominates the makeup of this index, it also includes a healthy dose of consumer discretionary, healthcare and financial companies.
Besides the high level of diversification and sector allocation, one of the most attractive features of VUG is its ultra-low expense ratio of just 0.09%. In addition, this index fund sports a very healthy asset base of $19 billion along with steady daily trading volume for excellent liquidity.
VUG has shown a penchant for outperformance as well. According to fund company data, VUG has gained 17.3% in average annualized return over the last half-decade, while the SPDR S&P 500 ETF (SPY) has notched a 16% profit (Vanguard uses data through the beginning of March).
Best Index Funds: Vanguard Extended Market ETF (VXF)
Click to Enlarge Balance is an important consideration when managing expectations for risk and return. With that in mind, you may want to consider supplementing the large-cap exposure of VUG with index funds focusing on small and mid-sized stocks as well.
One way to do that is to consider a broad-based ETF such as Vanguard Extended Market ETF (NYSEARCA:VXF).
VXF combines both small- and mid-cap stocks into a single basket to simplify your portfolio management. These more aggressive equities can show greater volatility, but also have been known to dominate returns in strong bull markets.
This ETF includes more than 3,200 stocks spread across a variety of sectors and market caps. Well-known names such as Tesla Motors Inc (NASDAQ:TSLA), Las Vegas Sands Corp. (NYSE:LVS) and American Airlines Group Inc (NASDAQ:AAL) are some of the top holdings in VXF.
This fund has $4.1 billion in total assets and charges an annual expense ratio of just 0.1%.
Best Index Funds: iShares Core MSCI Total International Stock ETF (IXUS)
Click to Enlarge Most investors focus a significant portion of their portfolio on domestic stocks because they have a better understanding and bias toward their home country. Nevertheless, a truly diversified portfolio should include exposure to international stocks as a way to enhance your returns and broaden your equity allocation.
iShares Core MSCI Total International Stock ETF (NYSEARCA:IXUS) is one of the best index funds to harness both developed and emerging market stocks overseas. This iShares trust includes exposure to Europe, Asia, and other global growth areas. Japan, the United Kingdom and Canada represent the top three countries within this index fund.
One of the advantages of a fund like IXUS versus the iShares MSCI EAFE Index Fund (ETF) (NYSEARCA:EFA) is the broader range of underlying countries and individual stocks. IXUS owns 3,400 securities versus just more than 900 for EFA and includes exposure to North and South America.
This ETF has $1.5 billion in total assets and charges a miniscule expense ratio of 0.14%.
Best Index Funds: Vanguard REIT ETF (VNQ)
Click to Enlarge Owning traditional stock index funds is an important component of a growth strategy. However, it is just as important to include unconventional or alternative asset classes as well. This approach increases diversification, enhances portfolio yield, and can increase returns through strategic positioning.
Publicly traded real estate investment trusts provide direct access to the real property market with liquidity and attractive dividend streams.
One of the best index funds that allow you to invest in a basket of these REITs is the Vanguard REIT ETF (NYSEARCA:VNQ).
This Vanguard REIT index fund invests in more than 140 REITs spread across retail, residential, healthcare, office and other specialty sectors. Top companies include well-known names such as Simon Property Group Inc (NYSE:SPG) and Public Storage Inc (NYSE:PSA).
VNQ has an effective yield of 3.39% and dividends are paid quarterly to shareholders. In addition, this $28 billion fund only charges a 0.1% expense ratio annually.
Low cost, high yield and favorable diversification are just some of the reasons that make this ETF an important holding to complement your wealth accumulation efforts.
Best Index Funds: iShares Core Growth Allocation ETF (AOR)
Click to Enlarge The iShares Core Growth Allocation ETF (NYSEARCA:AOR) takes a somewhat different tact by selecting an underlying mix of stocks and bonds through other diversified ETFs.
Previously the iShares S&P Growth Allocation Fund, this ETF is perfect for investors that may have smaller accounts, where trading fees would eat into profits for multiple positions. It can also be useful for those that are more concerned about risk and want a balanced index at the core of their portfolio.
As the name implies, AOR is focused on growth through a 60% weighting in domestic and international stocks. In addition, it complements that approach with 40% of the portfolio dedicated to high-quality fixed income to smooth out volatility.
This global and sensible approach helps mitigate the risks of an all-stock portfolio through a low-cost index fund. AOR charges an expense ratio of 0.24%* and can be used as a central holding or as a building block from which to build off of with more strategic positions.
* Includes a 0.14% fee waiver through at least Nov. 30, 2015
Final Note: Fixed Income
These index funds can be used as tools to access a specific segment of the market rather than trying to pick individual stocks or buy high-fee mutual funds. However, they are always susceptible to the whims of price volatility, which is why I recommend pairing them with a stop loss or sell discipline. This will allow you to participate in the upside, while reducing your downside risk.
I think it’s worth noting that the lack of attention toward fixed income was an intentional omission. In my opinion, there are overwhelming risks to a broad-based index bond fund such as the iShares U.S. Aggregate Bond ETF (NYSEARCA:AGG), formerly the iShares Barclays Aggregate Bond Fund. These indices are often tied too closely to Treasury and investment grade bonds that are highly susceptible to interest rate swings.
In addition, they offer low income yields and poor performance versus several actively managed equivalents. The ability to control credit, duration, sector and security selection is a huge advantage in the fixed-income world because of the wide dispersion in risk dynamics.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. As of this writing, the author was long AOR and IXUS. Clients of FMD Capital Management own VUG and VNQ. Learn More: Why I love ETFs, And You Should Too
