As part of a diversified portfolio, investors are increasingly buying index funds. These low cost vehicles enable market participants to track a specific stock market index such as the S&P 500, which measures the stock performance of the largest publicly-traded 500 domestic companies.
Index funds are an easy and oftentimes cheap way for investors to add diversification to portfolios. Laura Gonzalez, Ph.D., associate professor of Finance at California State University, Long Beach, says index funds, coupled with smart saving, are key to a retirement portfolio:
“Index funds are the staple of retirement portfolios… Anybody, including entrepreneurs, should start in their twenties putting aside a couple of hundred dollars every month. With low management fees and index diversification, portfolios navigate the ups and downs of the markets for decades, and time takes care of compounding towards an on-time comfortable retirement for all.”
An index is a passive investment approach as it typically tracks returns on a buy-and-hold basis. With that information, here are 7 of the best index funds to buy:
- SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA)
- Health Care Select Sector SPDR Fund (NYSEARCA:XLV)
- Invesco QQQ Fund (NASDAQ:QQQ)
- iShares PHLX Semiconductor ETF (NASDAQ:SOXX)
- SPDR S&P 500 ETF (NYSEARCA:SPY)
- Vanguard Consumer Staples Index Fund ETF (NYSEARCA:VDC)
- Utilities Select Sector SPDR (NYSEARCA:XLY)
Through these funds, investors can also buy into specific sectors of the economy. Today, we will discuss seven of the best index funds to buy.
Best Index Funds to Buy: SPDR Dow Jones Industrial Average ETF (DIA)
52-week Range: $182.10 – $295.87
Dividend Yield: 2.36%
Expense Ratio: 0.16% per year
Many long-term investors put a certain percentage of their money into blue-chip names, which are large-capitalization market leaders with brand recognition. They also tend to have decades of earnings and cash flow growth. Several indices and benchmarks, such as the Dow Jones Industrial Average (DJIA) track large-cap companies.
The index, also referred to as the Dow 30, was created by Charles Dow in 1896. Therefore, it’s not a big exaggeration to regard the DJIA as a continuous barometer of the U.S. stock market. Many investors worldwide track its daily performance to get a better gauge of the overall health of the market.
InvestorPlace.com readers looking for exposure to a range of large-cap stocks within the Dow may want to put the SPDR Dow Jones Industrial Average ETF on their radar screen. It is a price-weighted index. Put another way, higher priced stocks have a higher impact on the value of the DJIA. Obviously, the same holds true for DIA. United Healthcare (NYSE:UNH), Home Depot (NYSE:HD), and Amgen (NASDAQ:AMGN) top the list of the name in DIA.
Year-to-date (YTD), the fund is down about 3%. Its trailing P/E and P/B are 22.01 and 3.61. The final quarter of the year may put pressure on many share including the large-caps of the Dow 30 index. However, longer-term investors may consider buying the fund, especially if the price declines toward $250.
Health Care Select Sector SPDR Fund (XLV)
52-week Range: $73.54 – $109.74
Dividend Yield: 1.95%
Expense Ratio: 0.13% per year
2020 has put healthcare on the top of the priority list for billions of people worldwide. Market participants who would want to invest in businesses in the pharmaceuticals, biotechnology, health care equipment and services, may want to do due diligence on the Health Care Select Sector SPDR Fund which tracks the Health Care Select Sector index.
The fund’s sector allocation includes Pharmaceuticals (29.19%), Health Care Equipment & Supplies (27.84%), Health Care Providers & Services (18.55%), Biotechnology (15.23%), and Life Sciences Tools & Services (8.63%). XLV currently invests in 63 companies. The top three names are Johnson & Johnson (NYSE:JNJ), UnitedHealth Group, Merck (NYSE:MRK). Its top ten holdings comprise around half of net assets, which stand at $24 billion.
A study by McKinsey highlights, “Healthcare is an essential, dynamic, and opportunity-rich industry. The demand for innovation to drive simultaneous improvement in health outcomes, affordability, quality, and access will continue to be high.” And according to a recent report by PWC, “An ageing population and growing middle class are shifting healthcare needs and responses.”
Since the start of the year, the fund is up about 2%. Its trailing P/E and P/B are 17.64 and 4.43.
We’re all likely to need healthcare at some point in our lives. If you believe the industry will continue to grow during the decade, the you may consider buying XLV, especially if the price moves toward $100, or even below.
Invesco QQQ Fund (QQQ)
52-week range: $164.93 – $303.50
Dividend Yield: 0.74%
Expense Ratio: 0.20%
Our next discussion centers around the NASDAQ 100 index and the Invesco QQQ Trust that tracks it. The NASDAQ 100 is made up of the largest (based on market cap) non-financial companies listed on the NASDAQ Stock Exchange.
Following the Great Recession of 2008/09, growth-oriented tech stocks have shown an extremely robust performance, based on solid fundamentals. Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), and Amazon (NASDAQ:AMZN) head the list of firms in the fund. The top ten names account for about 55% of assets.
QQQ is up about 28% for the year. Since March, it has had a strong performance and increased by about 65%. As a result its trailing P/E (47.02) and P/B (12.58) ratios have also gone up considerably. But with the September pullback, investors’ risk appetite has changed. Many names in the NASDAQ 100 and thus the fund are currently having considerable pullbacks.
It is hard to know if this is a correction or the early days of a bear market. However, if you believe that the names in the index will possibly continue to outperform broader markets in the coming quarters, then you may want to buy QQQ during this profit-taking.
iShares PHLX Semiconductor ETF (SOXX)
52-week Range: $167.79 – 324.26
Dividend Yield: 1.37%
Expense Ratio: 0.46% per year
We continue the discussion on the tech sector by looking at semiconductor stocks, which have been pivotal catalysts in the bull run of the past decade. Year-to-date, the widely followed Semiconductor Index (INDEXNASDAQ:SOX) is up close to 20%.
The semiconductor industry is cyclical. Periods of high demand typically lead to higher prices and revenue growth. And the reverse happens when global economies contract. As a result, revenues in semiconductor firms ebb and flow significantly. The global industry is currently about $600 billion and expected to go over $800 in 2024. A recent report by Deloitte highlights, “Semiconductors serve as the foundation for enabling emerging Internet of Things (IoT) technologies. The IoT revolution has increased the demand for semiconductor chips but also shifted value capture to software and solutions.”
The iShares PHLX Semiconductor ETF, which follows SOX, is one of the most well-known funds. Because it is a cap-weighted fund, SOXX tilts toward the largest semiconductor stocks. The top ten names make up around 60% of net assets which stand close to $3.7 billion. Broadcom (NASDAQ:AVGO), Intel (NASDAQ:INTC), and Texas Instruments (NASDAQ:TXN) are the top three names in the ETF.
So far in the year, SOXX is up about 20% and hit an all-time high on Sept. 2. Trailing P/E and P/B ratios are 29.94 and 5.52.
We can expect many robust semiconductor companies to continue to play crucial roles in technological developments, especially in areas such as artificial intelligence (AI), autonomous driving, robotics, 5G, manufacturing, and healthcare, among others. Therefore, long-term investors may consider buying into the declines.
Best index funds: SPDR S&P 500 ETF (SPY)
52-week Range: $218.26 – $358.75
Dividend Yield: 1.69%
Expense Ratio: 0.09% per year
Our next fund is the SPDR S&P 500 ETF, which tracks the S&P 500 index. It was launched in 1993 as the first exchange-traded fund listed in the U.S. Assets under management are close to $300 billion. Therefore, it is a highly liquid fund.
For many in the markets, the performance of S&P 500 shows how domestic equities have done over a given period of time. Businesses in the S&P constitute around 80% of the overall value of the U.S. stock market. They also cover close to 25 separate industry groups. The top three names in the fund are Apple, Microsoft and Amazon. The S&P 500 is a cap-weighted index. Therefore, companies with the largest market caps have the highest weights in the index.
So far in the year, SPY is up about 4%. However, since the lows seen earlier in March, it has rallied about 50%. In fact, on Sept. 2, it reached an all-time high. As a result, the trailing P/E (23.95) and P/B (3.58) ratios have become richly valued.
Broader markets are volatile with a downward bias now. We are also about to enter a busy earnings seasons, to be followed by the U.S. Presidential election. There may be wild swings in share prices in the coming weeks. However, if you believe in the future the U.S. economy, then you may use SPY to have exposure to the companies in the index. We’d buy the dips in the fund.
Best index funds: Vanguard Consumer Staples Index Fund ETF (VDC)
52-week Range: $120.70 – $172.31
Dividend Yield: 3.01%
Expense Ratio: 0.10% per year
Consumer staples stocks typically form a significant percentage of many long-term portfolios. You may also see them referred to as “Consumer Non-Cyclicals.” These businesses manufacture or market staple items such as food and drink, household goods and personal hygiene products, which we all have to buy on a regular basis.
According to the National Bureau of Economic Research, the U.S. economy is officially in recession. And consumer staples stocks tend to be defensive and do well even when the economy hurts. Analysts highlight that owning shares of consumer staples companies may help protect your portfolio during periods of economic contraction.
In fact, despite the various uncertainties posed by the pandemic, many of these stocks have not only held their value but have also made new highs. Furthemore, many of them also provide robust dividends, which passive income seekers understandably like.
The index fund we’d recommend investors research would be the Vanguard Consumer Staples Index Fund ETF, whose benchmark index is the Spliced US IMI Consumer Staples 25/50. VDC has 94 holdings and Procter & Gamble (NYSE:PG), Coca-Cola (NYSE:KO), and Walmart (NYSE:WMT) top the list. The most important sectors (by weighting) are Household Products (25%), Soft Drinks (20.10%), Packaged Foods & Meats (17.20%), and Hypermarkets & Super Centers (13.90%).
YTD, VDC is up about 1%. However, since the lows seen in early spring, the fund has gone up over 35%. The fund’s trailing P/E and P/B ratios stand at 25.5 and 5.2. A price decline toward the $150-level would make the fund’s risk/return profile more attractive.
Utilities Select Sector SPDR Fund (XLU)
52-week Range: $43.44 – $71.10
Dividend Yield: 4.02%
Expense Ratio: 0.13% per year
Following a choppy September, markets have started October on a volatile note, too. Therefore if you are an investor who seeks some passive-income stability, then you may want to learn more about the Utilities Select Sector SPDR Fund.
No matter what the state of the economy is, we have to use electricity, water as well as gas, which means demand for utilities tends to be stable over time. Most utility firms operate in a regulated environment, which usually translates into modest but dependable profits.
They also have stable and high cash flows. As a result, they tend to be high-dividend payers. The current low interest rate environment also benefits utility businesses as they carry high levels of debt on their balance sheets. Low rates help their bottom lines.
XLU, which was first listed in 1998, tracks the Utilities Select Sector Index. The fund provides exposure to utilities as well as independent power producers and energy trader industries. NextEra Energy (NYSE:NEE), Duke Energy (NYSE:DUK), and Dominion Energy (NYSE:D) top the list of 28 companies. YTD, the fund is down about 6%. Its trailing P/E and P/B ratios stand at 2.11 and 19.03. A price decline toward $57.5 would improve the margin of safety for long-term investors.
On the date of publication, Tezcan Gecgil did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. She also publishes educational articles on long-term investing.