The best index funds on the market are also among Wall Street’s best tools for the thrifty and lazy alike.
Want the diversification of 500 companies without having to buy each stock in painstakingly calculated allotments and eating gobs of trading fees? The SPDR S&P 500 ETF Trust (SPY) exchange-traded fund has you covered as both a simpler and cheaper way of doing it.
That’s why, as I see the usual May slate of set-it-and-forget-it stock portfolios (and we’re guilty!), I groan a little. Because if you really want the best way of investing without having to think for a few months, short of going to cash, you’re better off seeking out the best index funds for defense — not individual stocks, which are much more susceptible to quick trips lower.
But the best index funds for going on defense do share something in common with defensive stocks in that several of them are good holdings for anytime — not just when you think the market’s about to faceplant. That’s because many of these ETFs boast sizable yields and bulletproof holdings that, over time, can actually outperform the market on a total return basis.
So yes, this list of 10 ETFs represents the best index funds you can use to shield your head for a few months. But many of these funds are also well-suited for holding in retirement and other long-term portfolios.
The Best Index Funds to Buy Now: iShares U.S. Preferred Stock ETF (PFF)
Expenses: 0.47%, or $47 per $10,000 invested
If you want to get a look at what a real set-it-and-forget-it investment looks like, check out the iShares U.S. Preferred Stock ETF (PFF), one of my favorite index funds and the very first security I bought after opening my IRA.
The PFF is made up of “preferred stock” — a type of high-yielding share that’s typically referred to as a stock-bond hybrid because it incorporates features of each. For instance, preferred stock does trade daily on an exchange. However, it pays a fixed dividend and typically doesn’t include voting rights, just like a bond.
They’re “preferred” shares because their dividends must be paid before common shares, which means in the event of a dividend cut, common dividends will be suspended before preferreds will — a small amount of protection.
Yields of 5% and 6% are commonplace in preferred stocks, and PFF itself yields a fat 5.75%. Meanwhile, volatility is extremely low compared to regular stock because preferred shares tend to trade around their “par value” (just like bonds).
Since January 2010, the fund has been locked in a range between $35 and $40 — so a maximum difference of just more than 12% from trough to peak. But in that time, PFF has returned 7.2% annually. That’s hardly the same as the S&P 500’s total return above 11%, but it also has come with far less volatility, and those returns are almost wholly in pure income.
Yes, you can point out that PFF got killed during the 2008-09 financial crisis, but so did everything else. But if your idea of “set-it-and-forget-it” needs to factor in once-in-a-lifetime crises, I’d suggest going 100% to cash every time you want a break.
The Best Index Funds to Buy Now: Guggenheim Defensive Equity ETF (DEF)
The Guggenheim Defensive Equity ETF (DEF) is an out-and-out attempt at finding the best collection of stocks that can weather bear runs. It seeks out “defensive market sectors that have historically outperformed in down markets,” and it equally weights its positions as an added layer of protection.
You might laugh (or shudder), then, at the idea that DEF’s top sector weighting goes to financials, but that moniker is a bit misleading.
Based on DEF’s sector definitions, “financials” also include the high-yielding real estate investment trust space — and in fact, that’s what the overwhelming majority of the sector’s holdings in the fund are. So, you’re looking at companies like mortgage REIT Annaly Capital Management, Inc. (NLY) and tech-focused real estate firm Digital Realty Trust, Inc. (DLR). Not big banks.
Otherwise, you’re looking at heaping helpings of utility companies, consumer stocks, telecoms and industrials that really do make it one of the best index funds for when things get ugly. To wit, DEF kicked tail with a total return of 13% in 2011 — a year in which the S&P 500 basically finished flat, and the SPY returned just 1.89% thanks to dividends.
The Best Index Funds to Buy Now: PowerShares S&P 500 Low Volatility Portfolio (SPLV)
Here’s a freebee: When it comes to equities, everyone should own an S&P 500-tracking ETF as part of their core portfolio. I personally own the Vanguard S&P 500 ETF (VOO) because of its lowest-in-class expenses, but you can’t go wrong with any of the exchange-traded S&P 500 index funds.
However, if you’re looking for a way to not only invest in large-cap stocks broadly with less wiggle than the S&P 500, but with better performance, I suggest the PowerShares S&P 500 Low Volatility Portfolio (SPLV).
The idea is simple: SPLV simply holds the 100 stocks from the S&P 500 that exhibit the lowest realized volatility over a 52-week period, which in theory should produce a set of relatively stable components. So no big surprise, then, that consumer staples make up nearly a quarter of the fund, and that industrials, healthcare and utilities all hold double-digit weights.
To further balance the fund, the stocks are equally weighted at each rebalancing so no stock represents more than 1% of the ETF’s holdings. This figure naturally moves as stocks go up and down between rebalancings, of course, so current top holdings The Coca-Cola Co (KO) and DaVita HealthCare Partners Inc (DVA) are slightly “overweight” at 1.26%.
Best of all, SPLV outperforms SPY in just about every meaningful time frame, most notably over the past year, where SPLV returned more than 9% versus 1% in total losses (so, dividends included) for the S&P 500 tracking ETF.
Read more about the SPLV here.
The Best Index Funds to Buy Now: iShares Core High Dividend ETF (HDV)
Another way to hunker down for the long summer months is to jump into big, blue-chip dividend stocks that investors swarm to for protection amid more volatile markets, but those get bid up slowly during good times, too, thanks to their strong businesses.
One of the best index funds for this goal is the iShares Core High Dividend ETF (HDV).
HDV aims to provide access to 75 dividend stocks “screened for financial health.” Obviously, that leaves a lot up to interpretation, but the result is a heavy bent toward big, cash-rich and/or high-cash-generating stocks that pay out substantial dividends, such as Exxon Mobil Corporation (XOM), Verizon Communications Inc. (VZ) and Johnson & Johnson (JNJ).
And unlike many dividend ETFs that say “dividend” but offer only modest yields, HDV offers a nice 3.6% in annual yield — nothing that will blow the roof off, but a relatively high payout for a standard equity fund.
As a bonus, you’re getting substantially less volatility than the S&P 500 at a beta of 0.7, and you’re getting performance as investors get defensive in this flat market, with HDV actually up 7% for the year-to-date.
The Best Index Funds to Buy Now: Legg Mason Low Volatility High Dividend ETF (LVHD)
So, we like low volatility, and we like high dividends.
It’d be kind of difficult to argue against the Legg Mason Low Volatility High Dividend ETF (LVHD), then, huh?
First things first: This is an extremely young index fund that, as of this writing, was just short of five months in operation. So there’s not much way of knowing how this particular ETF acts in different environments.
Still, a look at LVHD’s holdings can give us an idea of what to expect.
Waste Management, Inc. (WM). Altria Group Inc (MO). General Mills, Inc. (GIS). You can go up and down the portfolio and find examples of quality dividend stocks with the kinds of businesses that simply don’t take a break. Nearly a quarter of the fund is locked into utilities, and industrials and consumer staples both have double-digit weightings.
And even if one of LVHD’s holdings were to blow up, it wouldn’t do too much damage — the largest weight for any stock in the ETF is 3.03% for Cummins Inc. (CMI).
Just like HDV, LVHD’s 3.3% yield isn’t enormous, but it’s still generous for a fund of traditional dividend stocks.
Read more about the LVHD here.
The Best Index Funds to Buy Now: Vanguard Dividend Appreciation ETF (VIG)
Big yield is one of a few ways you can peel the dividend onion. Another way is dividend growth.
Vanguard Dividend Appreciation ETF (VIG) focuses on exactly that. And yes, while the strategy does provide bigger yields over time (an investor who bought in at the beginning of 2013 earned 2.2% in yield by the end of that year, but 2.9% in 2015), headline yield isn’t the real story here.
VIG invests in 185 “Dividend Achievers,” which are companies that have increased their dividends for at least 10 consecutive years. (Think of it as a lesser version of Dividend Aristocrats [25 years], though the list does include Aristocrats, including top holdings JNJ and KO.)
While the ability to increase your dividends year after year certainly speaks to … well, increasing dividends, it also speaks to a certain amount of financial stability and consistency that produces less volatile, more dependable stocks. VIG’s holdings on average are slightly larger than $51.6 billion in market cap.
As a result, the ETF sports a sub-1 beta, and the fund has roughly doubled the S&P 500 amid a topsy-turvy year.
The Best Index Funds to Buy Now: iShares Edge MSCI USA Quality Factor ETF (QUAL)
The iShares Edge MSCI USA Quality Factor ETF (QUAL) is the last of the pure equity funds on the list, and it does things a little differently.
The focus here is on quality rather than simply defensive characteristics, though metrics like “high return on equity, stable year-over-year earnings growth and low financial leverage” definitely feels like it would produce the same list of stodgy blue chips we’ve seen in the previous funds.
It does, but it also creates a makeup that’s unlike the other funds. Information technology makes up the largest portion of Edge’s weight at nearly 20%, with Microsoft Corporation (MSFT) and Apple Inc. (AAPL) leading the way on that front. There’s also 14%-plus exposure to healthcare stocks like Gilead Sciences, Inc. (GILD), and QUAL boasts one of the highest weightings in consumer discretionary stocks on this list, at nearly 14%.
Given some of those top holdings, QUAL probably has the largest potential for swings in the near future, but realize that even the ETF’s biggest drops since inception have been around 8% (and it has recovered from both in short order). There’s just too much blue chip in QUAL to keep it submerged for long, short of an outright market collapse.
Read more about the QUAL here.
The Best Index Funds to Buy Now: Vanguard Short Term Corporate Bond ETF (VCSH)
It doesn’t get much more set-it-and-forget-it than the Vanguard Short-Term Corporate Bond ETF (VCSH), to the point that you’ll probably want to set an alarm, too.
This fund is a snoozer.
VCSH invests in investment-grade corporate bonds with an average maturity of one to five years.
Yes, it seems like lunacy (or idiocy) to suggest a bond fund when the Federal Reserve seems destined to hike interest rates again at least once more this year. After all, when interest rates rise, prices on existing bonds fall.
But that’s what makes VCSH an ideal bond holding right now. See, duration — how long it takes for a bond’s price to be repaid — is also a gauge of how sensitive bonds are to changes in interest rates; the higher the duration, the worse off that bond is going to be. (Check out Morningstar’s explanation, which includes some helpful example math.)
Because the VCSH invests in low-duration bonds, its holdings won’t be hit as badly by an interest-rate hike as funds with higher-duration bonds.
Not to mention, any hike is likely to be something small, like a quarter-point, to a range of 0.5%-0.75%. This would be a different conversation if the Fed was mulling 7% rates overnight.
And, of course, as bonds in the VCSH mature, the fund replaces them with newer issues, which likely will be yielding more as a result of higher rates.
There are “safer” bonds than short-term corporates, such as ultra-short-term government bonds, but at that point, you’re often looking at sub-1% yields. At least at 2% for the VCSH, you’re beating the U.S. inflation rate while ducking for cover.
Read more about the VCSH here.
The Best Index Funds to Buy Now: iShares Core Conservative Allocation ETF (AOK)
The iShares Core Conservative Allocation ETF (AOK) might be the ultimate lazy man’s approach, as this one ETF merely invests in what its index says are 10 of the best index funds to produce a conservative holding core.
The mix as of right now is very bond-heavy, with 68% in fixed income, 31% in equity and 1% in cash. The top holding is the wide-reaching iShares Core Total USD Bond Market ETF (IUSB), which invests in everything from Treasuries to mortgage-backed securities to corporates. The iShares S&P 500 tracker, iShares Core S&P 500 ETF (IVV), is next at nearly 15%.
Other bond funds make up another 35% or so of AOK’s assets, followed by a smattering of ETFs covering European, Pacific, emerging market, U.S. mid-cap and U.S. small-cap stocks.
AOK is true to its name, providing a much gentler ride than the broader market, making it an acceptable hideout until you’re sure you want to get more aggressive. Just don’t expect to ride this ETF to greatness — since inception in late 2008, AOK has underperformed the SPY with 5.9% annual returns compared to the S&P 500 ETF’s 13.5%.
*The expense ratio will be 0.24% through Nov. 30, 2016, due to a partial waiver of management fees.
The Best Index Funds to Buy Now: PowerShares DB US Dollar Index Bullish Fund (UUP)
The PowerShares DB US Dollar Index Bullish Fund (UUP) tracks the U.S. dollar against six currencies — the euro, yen, British pound, Canadian dollar, Swedish Krona and Swiss franc. More simply put, as the name would suggest, the UUP is a bullish bet on the dollar.
A note before we go any further: Of all the plays on this list, the UUP is the shortest-term play by a mile, and the one that requires the most monitoring.
It’s not that the UUP inherently lacks volatility — the dollar can certainly move given various global economic factors — it’s just that for the near-term, the dollar looks like a solid and possibly profitable investment.
That’s because much of the rest of the world — especially Europe and Japan — appear happy to keep the economic stimulus train chugging, with both outlining plans in March for additional measures (though Japan’s latest economic data have quelled calls for even more immediate action).
Meanwhile, the U.S. might hem and haw about whether we’ll see a next interest-rate hike in June, but the point here is that it’s even an option. The U.S. economy is showing enough strength that another rate hike seems inevitable at some point this year, and that alone should be enough to keep the U.S. dollar — and thus the UUP — firm for at least a few months, if not longer.
Kyle Woodley is the Managing Editor of InvestorPlace.com. As of this writing, he was long DLR, PFF, SPLV, VOO and XOM, and was considering entering a position in UUP in the next 48 hours. Follow him on Twitter at @KyleWoodley.