It’s tough to beat index funds when it comes to long-term investing. But don’t settle into any passively managed fund that comes across your screen — taking the time to find the best index funds will pay off in the long run.
The qualities to look for in the best index funds will include low expense ratios, tight index tracking and broad diversification.
When it comes to index investing, some investors prefer exchange-traded funds for their low expense ratios, especially the big ones that track the S&P 500 index, such as SPDR S&P 500 ETF (SPY) and iShares Core S&P 500 ETF (IVV).
However, with the exception of investing in sectors, I prefer index mutual funds for long-term investing, primarily because many long-term investors are dollar-cost averaging and mutual funds often trade without transaction fees, whereas ETFs commonly have small commissions that add up over time.
Not to mention, most 401ks don’t allow investors to invest in ETFs, meaning mutual funds might be your only choices.
With that backdrop, I give you the best index funds to buy for the long run:
Best Index Funds to Buy for the Long Run: Vanguard Balanced Index (VBINX)
Expenses: 0.23%, or $23 for every $10,000 invested
Minimum Initial Investment: $3,000
The best index fund that combines a diversified balance of U.S. stocks and high-quality bonds may be Vanguard Balanced Index (VBINX).
Although VBINX does not get as much media attention as S&P 500 index funds and total stock market index funds, investors are wise to give their own attention to this outstanding “set it and forget it” fund.
VBINX deservedly received attention on this site earlier this year when I highlighted it in my story on Vanguard funds vs. hedge funds, where I made a comparison of performance through 2014:
“In 2014, VBINX was up 9.8%, compared to the average hedge fund’s performance of just 3%. To capture a broader time period and a full market cycle in a comparison, the Vanguard Balanced Index fund’s 10-year annualized return is 7.3%, compared to 5.1% for hedge funds. A simple, low-cost balance of roughly 60% stocks and 40% bonds beats hedge funds!”
Vanguard Balanced Index can be used as a standalone option or as a solid core holding in a diversified portfolio of mutual funds. Recent top stock holdings include Apple (AAPL), Microsoft (MSFT) and Exxon Mobil (XOM).
Best Index Funds to Buy for the Long Run: Fidelity Spartan 500 Index (FUSEX)
Minimum Initial Investment: $2,500
On occasion, Fidelity outshines Vanguard with index funds and Fidelity Spartan 500 Index (FUSEX) — with top holdings in Apple, Microsoft and Exxon Mobil — is a prime example.
If you’re looking to buy one of the best S&P 500 index funds, or any similar index fund, the two primary qualities to look for are low expense ratios and tight index tracking. If both are ideal, you’ll get the best long-term performance in relation to similar funds.
For example, Spartan 500 Index has a rock-bottom expense ratio of 0.09% and is a beneficiary of Fidelity’s excellent index-tracking skills.
Now, compare this to Vanguard — which may be the best indexer in the mutual fund industry — and its Vanguard 500 Index (VFINX), which has an expense ratio of 0.17%. We may call it a draw on the index tracking between the two mutual-fund behemoths, but the lower expense ratio on FUSEX gives it a slight edge for performance in the long run.
For example, the 10-year annualized return for FUSEX is 6.98%, whereas that of VFINX is 6.93%. The S&P 500 index returned 7.05% for the same period.
While this performance differential is slight, the most successful long-term investors tend to be the most frugal.
Best Index Funds to Buy for the Long Run: Vanguard Total Stock Market Index (VTSMX)
Minimum Initial Investment: $3,000
No list of the best index funds is complete without Vanguard Total Stock Market Index (VTSMX).
Currently the biggest mutual fund in the world, as measured by assets under management, VTSMX tracks the CRSP US Total Market Index, representing nearly 100% of the investable U.S. equity market.
The fund is cap-weighted, which means the largest stocks by capitalization represent more of the portfolio than smaller-cap stocks. Top holdings of VTSMX naturally include the biggest stocks out there, which are Apple, Exxon Mobil and Microsoft.
Compared to an S&P 500 index fund, Vanguard Total Stock Market has slightly higher market risk because it holds small- and mid-cap stocks, whereas the S&P 500 is 100% large caps. But that added risk will normally give VTSMX a boost in long-term returns compared to S&P 500 index funds.
For example, the 10-year annualized return for VTSMX is 7.31%, which edges out that of the S&P 500’s return of 7.05%.
VTSMX makes an outstanding core holding to use as a foundation for building a diversified portfolio.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities, although he holds FUSEX and VTSMX for some client accounts. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, SC. Under no circumstances does this information represent a recommendation to buy or sell securities.