At this point, everyone pretty much knows that index funds are some of the best building blocks for a balanced portfolio. Index funds offer instant diversification, giving investors exposure to hundreds of stocks or bonds in a single fund. And better yet — they typically outperform active managers over the long haul.
Low cost of ownership is a fat cherry on top, making it no surprise that index funds have amassed more than $2.1 trillion worth of investor cash as of the end of last year.
And unlike some things in life, some of your best index fund options are the cheapest ones.
Expense ratios — the cost of fund ownership expressed as a percentage — continue to drop like a stone. Some cheap index funds now cost less than $10 a year in fees on every $10,000 invested! Compare that to many mutual funds that can cost $100, even $150 every year in expenses.
A difference of $100 might sound minuscule, but consider this — a 1-percentage-point difference in expenses on a $10,000 investment making 6% a year will result in a nearly $14,000 difference in returns over the course of 30 years.
Thanks to the wealth of cheap index funds on the market, it’s easy to not just build an inexpensive portfolio, but an inexpensive portfolio that will cover a huge swath of the investing world.
With these cheap index funds, you’ll be plenty diversified — and for just more than 50 bucks a year.
Cheap Index Funds to Buy: Vanguard S&P 500 ETF (VOO)
Expense Ratio: 0.05%, or $5 for every $10,000 invested
Total Annual Expenses of Portfolio: $5/$10,000
Large-cap U.S. stocks form the backbone of almost any portfolio. But investors should skip the often touted Dow Jones Industrial Average and stick to the more diversified S&P 500 instead.
The cheapest way to own this is the $34 billion Vanguard S&P 500 ETF (VOO).
The VOO employs a passively managed, full-replication strategy, which means the exchange-traded fund will own all the stocks in the index. With the VOO, investors get exposure to leading stock market stalwarts like consumer-tech giant Apple (AAPL) and integrated energy producer Exxon Mobil (XOM), plus the remaining names in the S&P 500.
This simple strategy of owning this wide basket of U.S. companies has led to some stellar results. Since 2010 inception through the end of August, the VOO has managed to produce annual returns of 14.97%.
Also pretty stellar is the expense ratio. The VOO’s 0.05% in annual fees make it one of the best cheap index funds — and the cheapest S&P 500 fund — to own.
Cheap Index Funds to Buy: Vanguard Extended Market ETF (VXF)
Expense Ratio: 0.1%, or $10 for every $10,000 invested
Total Annual Expenses of Portfolio: $15/$10,000
Index funds can also help fill out a portfolio as well. Designed by Standard & Poor’s to complement an investment in the S&P 500, the S&P Completion Index tracks thousands of mid- small- and micro-cap stocks in the U.S.
These smaller firms are often faster growing and have managed to outperform large-caps over big stretches of time. The downside is that they do come with a hefty dose of volatility.
But by using index funds to package them all together, the volatility and single-company risk is minimized.
The Vanguard Extended Market ETF (VXF) tracks the S&P Completion Index and provides exposure to more than 3,358 different stocks. (That’s not a typo.) And by combining VXF with the VOO, investors basically have the U.S. stock market covered.
On its own, this “smid-cap” ETF has managed to do pretty well in the returns department. Since inception in 2001, VXF has produced 9.21% annual total returns through the end of August.
Cheap Index Funds to Buy: iShares Core Total USD Bond Market (IUSB)
Expense Ratio: 0.15%, or $15 for every $10,000 invested
Total Annual Expenses of Portfolio: $30/$10,000
Despite the looming specter of rising rates, bonds still play a major role in many diversified portfolios. They provide cushion and stability — thanks to their steady coupon payments — against the more volatile nature of stocks. And those coupon payments can be an important source of income for investors nearing or in retirement.
You can buy individual bonds, but if you want any sort of diversity in your bonds, that can become a difficult, time-consuming proposition, not to mention expensive. That’s why many investors get their bond fix via index funds.
One particularly underrated bond fund is the iShares Core Total USD Bond Market ETF (IUSB).
IUSB tracks the Barclays U.S. Universal Index. The beauty is that this index includes a variety of bond types that are not contained in the more popular U.S. Aggregate Bond Index. This includes higher-yielding bonds, agencies and other corporate securities. Consider IUSB a one-stop shop for the U.S. bond market.
It’s a pretty cheap one-stop shop at that. For just $15 annually on every $10,000 invested, you get access to more than 1,400 bonds.
Cheap Index Funds to Buy: Vanguard Total International Stock ETF (VXUS)
Expense Ratio: 0.14%, or $14 for every $10,000 invested
Total Annual Expenses of Portfolio: $44/$10,000
Index funds can get you globally diversified for dirt cheap as well.
Global diversification has its obvious benefits. Many of the world’s leaders in various sectors are domiciled overseas. Country of origin often has little to do with where a company sells its products. After all, you’re just as likely to use Anglo-Dutch firm Unilever’s (UL, UN) deodorant or drive a Honda (HMC) Accord. Then there are currency gains, not to mention a hedge against any U.S. weakness.
The Vanguard Total International Stock ETF (VXUS) tracks the FTSE Global All Cap ex US Index. This index covers nearly 6,000 global securities across Europe, Asia/Pacific, emerging markets and the parts of North America that we don’t occupy.
Of course, VXUS’ performance since 2011 inception reflects the broader notion that U.S. markets have been a much friendlier place than the rest of the world, with the ETF returning just more than 1% in that time.
Still, if and when the script flips, VXUS is a prime way to benefit.
Cheap Index Funds to Buy: Schwab US REIT ETF (SCHH)
Expense Ratio: 0.07%, or $7 for every $10,000 invested
Total Annual Expenses of Portfolio: $51/$10,000
Every portfolio — even one based on index funds — needs some spice. One particularly cheap source of spice is the Schwab US REIT ETF (SCHH), which invests in real estate investment trusts, or REITs.
Designed as a way for investors to own commercial real estate properties, REITs receive certain tax benefits but in exchange are required to dole out the bulk of their cash flows to investors. As a result, the sector’s components typically have much higher dividend yields than regular stocks.
Over the long haul, REITs have sported some pretty impressive total returns. And because REITs are generally not tightly correlated with stocks or bonds, they provide a great diversification tool for a portfolio.
The Schwab US REIT ETF (SCHH) tracks 95 different REITs, covering everyone from apartment and shopping mall owners to business parks and storage center operators. However, the fund only includes equity REITs — firms that actually own property — but no mortgage REITs, which typically buy mortgages or mortgage-backed securities and often deliver even higher yields.
The SCHH itself doesn’t sport a boffo yield. At just 2.4%, the yield actually seems miserly. But price appreciation is part of the game, too — and that’s where the SCHH catches up. Since early 2011, SCHH is actually outperforming the Vanguard REIT ETF (VNQ) by a few basis points on a total return basis.
As of this writing, Aaron Levitt was long VFIAX, which is a mutual fund version of VOO.