Index funds to buy are a great way for investors to gain broad exposure to certain asset classes of stocks. They can help reduce volatility (or embrace it) and certainly help with diversification.
Many investors feel that index funds are a better investment that individual stocks, even though the latter can have outsized returns. However, the simple fact of the matter is that many individual stocks lag the broader market over the long term. Some even fail completely by going bankrupt.
As a result, the idea of index funds vs. individual stocks isn’t so much a black-and-white situation, but rather one filled with plenty of gray areas. In other words, blending the two together can often yield great results when quality assets are paired with patience.
With that in mind, let’s take a look at seven cheap index funds for the careful investor.
- Vanguard S&P 500 ETF (NYSEARCA:VOO)
- SPDR S&P 500 ETF (NYSEARCA:SPY)
- Invesco QQQ ETF (NASDAQ:QQQ)
- Invesco S&P 500 Top 50 ETF (NYSEARCA:XLG)
- Vanguard Dividend Appreciation Index Fund (NYSEARCA:VIG)
- PIMCO 15+ Year US TIPS Index ETF (NYSEARCA:LTPZ)
- Invesco Taxable Municipal Bond ETF (NYSEARCA:BAB)
Index Funds to Buy: Vanguard S&P 500 ETF (VOO)
How can we start this list of index funds to buy without talking about the Vanguard S&P 500 ETF? This security has become well-known in investment groups large and small.
Vanguard is known for its low fees and wide appreciation. Legendary investor Warren Buffett has even endorsed that principle, saying, “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s).”
His firm even bought some VOO over the past year, as the Oracle puts his money where his mouth is.
As you may have guessed, the VOO is a collection of the S&P 500 holdings. This gives investors exposure to 500 different securities, helping to diversify their investment dollars.
With a gross expense ratio of just 0.03% — or $3 annually for every $10,000 invested — VOO is one of the cheapest ETFs of index funds out there.
While some investors may not want exposure to the S&P 500, others may want exactly that. After all, the S&P 500 is the general benchmark for the equities market — not the Dow or the Nasdaq.
So if you want to piggyback on the index, VOO is one of the best ways to do it, seeing as though you can’t actually buy shares of the S&P 500. But there is another way…
SPDR S&P 500 ETF (SPY)
The other option for the S&P 500 is the SPDR S&P 500 ETF. This is certainly a well-known ETF in the investment community and it should be, seeing as though it’s also the largest ETF.
When it comes to assets under management, the SPY is notably larger than the next largest ETF and is almost twice the size of the VOO.
That’s not to say the VOO isn’t a worthy holding, only that the SPY is much larger and more well known. With that comes more trading volume and thus, more liquidity. For instance, the average 10-day volume for the SPY is 65.7 million shares, whereas that figure stands at just 2.3 million for the VOO. The difference is more than 28-fold between the two.
It (hardly) matters, though.
That’s because the performance is virtually the same. There is one slight difference. Over the last 10 years, the VOO’s performance has topped the SPY 191.9% to 190.2%. This 1.7% difference is just a fraction per year, but it’s where the SPY’s 0.09% expense ratio stands out vs. the VOO’s expense ratio of just 0.03%.
It depends on what an investor wants, though. Set-it-and-forget-it performance or better liquidity and far better equity-option selections. VOO is the former, SPY is the latter.
For what it’s worth, Buffett was a buyer of both.
Invesco QQQ ETF (QQQ)
Branching away from the S&P 500 lands us in tech. While the Invesco QQQ ETF doesn’t track the Nasdaq Composite, it does track the Nasdaq 100, which gives investors exposure to the larger and more well-capitalized firms in the index. Plus, this group of index funds to buy tends to be less volatile and more stable than its smaller-cap peers.
Many investors may not consider tech as a “careful” place to invest. To some extent, that makes sense. But is the energy sector any less safe, just because it’s more traditional? How about financial stocks?
One could argue that tech is safer than either of these two sectors. One could also argue that it’s actually careless to not have exposure to tech at this point. Particularly given the balance sheet power collectively held in the top five holdings of the QQQ.
Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG), Facebook (NASDAQ:FB) and Amazon (NASDAQ:AMZN) have some of the strongest balance sheets, cash flow and margins in the entire market. Between the five stocks, they make up about 45% of the ETF’s total weighting.
More so, QQQ is the second-most actively traded ETF in the U.S., providing plenty of liquidity. Further, it’s “rated among the top 1% (2 of 321), best-performing large-cap growth funds over the past 15 years by Lipper, as of August 31, 2020.”
Invesco S&P 500 Top 50 ETF (XLG)
The Invesco S&P 500 Top 50 ETF is a really interesting one. It’s like a mashup between index funds to buy QQQ and SPY. On the one hand, its five largest stocks are the same as the QQQ. That’s Apple, Microsoft, Amazon, Alphabet and Facebook — in that order when considering Alphabet’s weighting for both classes of its stock (GOOG and GOOGL).
In any regard, rather than the top five holdings being followed up by stocks like Tesla (NASDAQ:TSLA) or tech, it’s what many consider safer stocks. Those are the ones from the weighting of the S&P 500.
A blend of SPY and QQQ is also a good description for the XLG ETF when it comes to performance. The XLG is up about 23.5% over the past 12 months. That tops the SPY’s 14% gain, but lags the QQQ’s 46.2% run.
That observation rings true over both the short and long term. Over the last one-, three-, five- and 10-year periods, the XLG outperforms the SPY and underperforms the QQQ.
If you want a marriage between the two funds, the Invesco S&P 500 Top 50 ETF is as good as it gets.
Vanguard Dividend Appreciation Index Fund (VIG)
Let’s waltz back to the Vanguard selection and scoop up something that every cautious investor looks for: yield.
There is rarely a shortage of income-oriented investors in the stock market, making the VIG ETF a perfect selection.
The yield is a bit low compared to many other individual stocks out there, sitting at just 1.7%. However, that’s more than double the 80 basis points investors will fetch with the 10-year Treasury yield.
From the fund’s description: “The investment seeks to track the performance of a benchmark index that measures the investment return of common stocks of companies that have a record of increasing dividends over time.”
Its top holding is Walmart (NYSE:WMT), but is followed by names we are already familiar with in the funds above. That includes Microsoft, P&G, Johnson & Johnson and Visa.
In typical Vanguard fashion, the 0.06% expense ratio is among some of the lowest fees in the business. Plus its track record is pretty strong. The fund has generated a double-digit return in seven of the past 10 years, losing money just twice during that stretch. That came from its decline of 2% in 2018 and 1.95% decline in 2015.
Over the last decade, the VIG ETF has generated an average annual return of 12.5%.
PIMCO 15+ Year US TIPS Index ETF (LTPZ)
Let’s shift away from stocks for a minute and focus on bonds. Bonds are a tricky spot right now. There has been a lot of volatility in the group over the past 12 months, while yields are quite low. That’s not really what bond investors are seeking when looking at fixed income.
However, the PIMCO 15+ Year US TIPS Index ETF is hoping to change that — admittedly, with some strings attached.
First, the fund has only appreciated in seven of the past ten years. While not bad, that may raise a red flag for cautious and conservative investors. Worse, one of those declines clocked in at nearly 20% (in 2013).
However, in the following year, the fund generated a 19.6% gain. In the other six years of gains, the lowest result was a positive 8.67% gain.
Further, over the past five years — which excludes the volatile 2013 and 2014 stretches — the ETF sports an average annual return of 9.8%. That’s pretty darn solid for a bond fund. Consider that the another PIMCO ETF for short-duration bonds sports a five-year average return of just 2.4%.
So really, investors may feel they are being well-compensated for the additional volatility.
Finally, this is a five-star rated ETF by MorningStar overall, as well as over the last three-, five- and 10-year periods. With a gross expense ratio of just 0.20%, it won’t cost investors a lot in performance, either.
Invesco Taxable Municipal Bond ETF (BAB)
Last up on this list of index funds to buy is the Invesco Taxable Municipal Bond ETF (BAB). Those willing to sacrifice some of the performance from the last fund in lieu of other attributes can consider BAB.
Although the BAB ETF offers a lower annual average return than the LTPZ ETF we just talked about, it compensates investors with lower volatility and a larger yield. Plus, it’s fun to say: BAB ETF.
It’s slightly more expensive with a 0.28% gross expense ratio, but that’s hardly something to quibble about. Instead, take note of its 3.2% dividend yield and the fact that it’s a five-star rated fund by MorningStar. Like the LTPZ, this rating also applies over the past three, five and 10 years.
Getting into the performance, the BAB ETF has generated gains in eight of the past 10 years. In five of those eight years, the return exceeded 9.87%, and in two of the years, it topped 15%.
More importantly, its two down years were declines of 0.25% and 5.2%, which came in 2015 and 2013, respectively. That compares to the LTPZ, which lost 8.8% and 19.2% those years.
That said, the LTPZ’s five-year average return of 9.8% tops the BAB’s return average return of 6.8% in the same stretch. However, they have comparable 10-year average returns. In either case, there’s a little bit of everything here for investors.
On the date of publication, Bret Kenwell held a long position in AAPL, GOOGL and QQQ.