This has not been the best market for passive investing and index funds.
Certainly, major indices have rallied nicely from March 2020 lows. But that stretch has been perhaps the best in history for active retail investors. Most of the individual investors who flooded into Robinhood and other platforms as the world shut down wound up buying stocks at or near the bottom. And the sectors they often favored — like electric vehicles (EVs), online gambling and cryptocurrency — have outperformed those major indices.
Of course, 13 months of outperformance doesn’t necessarily make a long-term strategy. And we’ve seen some weakness of late in precisely those hot sectors. At the least, active investing is not as easy as it has seemed for some.
Thus, the long-term value of passive investing still exists. Proper, effective active investing takes up a substantial amount of time. Even in a zero-commission world, bid/ask spreads can erode returns, particularly for heavy traders. Index funds aren’t necessarily for every investor, but there is a logic to the long-term growth in passive investing’s market share.
Indexing works. It doesn’t work as well as beating the market, obviously, but beating the market over the long haul is much easier said than done. So, for investors still looking to put a portion or even all of their portfolios into passive options, here are seven of the best index funds to consider:
- iShares Core S&P 500 ETF (NYSEARCA:IVV)
- iShares Core S&P Total U.S. Stock Market ETF (NYSEARCA:ITOT)
- Invesco QQQ Trust (NASDAQ:QQQ)
- Vanguard Total World Stock ETF (NYSEARCA:VT)
- Vanguard FTSE All-World ex-US ETF (NYSEARCA:VEU)
- Vanguard Total Bond Market Fund (NASDAQ:BND)
- Vanguard Real Estate ETF (NYSEARCA:VNQ)
7 Index Funds to Consider: iShares Core S&P 500 ETF (IVV)
When institutional investors are referring to “the market,” they usually are referring to the S&P 500. The S&P 500 is the most commonly-used benchmark for active investors, making it a logical choice for passive investors looking to track overall returns.
Indeed, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) is the largest index fund by assets under management. IVV is second, while the Vanguard S&P 500 ETF (NYSEARCA:VOO) comes in fourth. Combined, the three exchange-traded index funds have over $850 billion in assets under management (AUM).
Any of the three funds is suitable for most investors. However, the slight edge here goes to IVV stock, which has a lower expense ratio than SPY (.03% versus .09%) and a higher AUM than VOO. Regardless of your choice of fund here, though, the S&P 500 is smart for passive investors all around. It’s large enough to provide diversification, stable enough to minimize volatility and small enough to keep fees as low as possible. There’s a reason three of the four largest index funds track the index.
iShares Core S&P Total U.S. Stock Market ETF (ITOT)
When it comes to index funds, some investors want even more breadth than the S&P 500 can provide, while still staying within U.S. confines. That’s where total market index funds like ITOT come in.
Total market isn’t exactly accurate, but it’s close. ITOT’s portfolio includes over 3,600 stocks.
The fund still is weighted toward large-cap names; Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), and Amazon (NASDAQ:AMZN) account for 12.8% of total assets. That compares to 15.6% for IVV. This added exposure to small- and large-cap stocks is significant, but not necessarily a game-changer.
Indeed, over the past decade, total returns for IVV have been 13.86% annualized, against 13.82% for ITOT. That exceedingly modest gap may reverse going forward, but it’s not very likely to expand significantly.
Still, index investing is about diversification. ITOT stock offers that diversification.
Invesco QQQ Trust (QQQ)
To gain outperformance, investors usually have to go a bit narrower with index funds. One option that has been hugely successful in recent years is the Invesco QQQ Trust.
QQQ stock tracks the Nasdaq 100, which includes 100 of the largest-capitalization stocks listed on the exchange. The Nasdaq historically has been more tech-heavy than the New York Stock Exchange, so QQQ holds the biggest tech winners of the past decade.
In fact, assuming an investor would not put Visa (NYSE:V) in the tech category, one of the most valuable U.S.-based tech companies listed on the NYSE is Oracle (NYSE:ORCL). That company’s value pales in comparison to some of the top U.S. tech names listed on the Nasdaq.
As a result, few if any index funds have done better than QQQ since the financial crisis. Since Mar. 1, 2009, the ETF has rallied over 1,100%. Appreciation in SPY has been less than half of that.
So far in 2021, that’s changed, with QQQ stock underperforming the S&P 500 and the Dow Jones Industrial Average. But I wrote this month that I expect the previous order to be restored as normalcy returns post-pandemic. Admittedly, QQQ’s focus adds more risk, particularly if tech valuations are at or near a peak. However, the potential rewards here shouldn’t be ignored, either.
Vanguard Total World Stock ETF (VT)
Investors in index funds of course aren’t limited just to U.S. names. In fact, there’s an argument that they should be focusing on international equities at the moment.
U.S. stocks have outperformed markedly since the financial crisis. In October 2019, American equities had outperformed by five percentage points annually. There are structural reasons for that enormous gap, but at some point — presumably — a rotation to non-U.S. stocks will occur.
The Vanguard Total World Stock ETF, or VT stock, offers a measured way to bet on that rotation. That’s because 60% of the fund’s assets are still invested in North America. Here, too, the top three holdings are AAPL, MSFT and AMZN. As with U.S.-based total market index funds, the additional exposure is incremental.
But that exposure has been meaningful so far; 10-year returns are just 9.49% annualized, more than four points below the S&P 500.
If foreign markets finally outperform, that may flip.
Vanguard FTSE All-World ex-US ETF (VEU)
Investors willing to bet on global equities can get more aggressive via ex-US index funds. After all, passive investing doesn’t require ownership of one single fund. Portfolios can be constructed and at this point ownership of non-U.S. equities seems logical.
VEU is the largest all-world ETF out there, with about $50 billion in assets. That scale allows for a reasonable 0.08% expense ratio, not terribly higher than S&P 500-tracking funds.
As the name suggests, the fund has broad geographic diversification. Europe accounts for 39% of the portfolio, emerging markets 26% and the Pacific region nearly 29%. The latter area drives the three biggest holdings — Taiwan Semiconductor (NYSE:TSM), Tencent (OTCMKTS:TCEHY) and Alibaba (NYSE:BABA) — which total about 5% of assets.
VEU stock is not suitable for 100% of an investor’s portfolio, certainly. But it’s a good way to get international exposure at a time when such exposure seems prudent.
Vanguard Total Bond Market Fund (BND)
Index funds aren’t just for stocks, of course. In fact, they’re particularly useful for fixed-income investments. Most individual portfolios aren’t large enough to own individual bonds without raising significant concentration risk. Actively managed mutual funds often charge 1% or more in expenses annually.
There is no shortage of bond index funds out there, but BND stock looks particularly good. It’s U.S.-focused, which seems attractive at the moment. Why? Interest rates in Europe are artificially low, with some corporate bonds offering negative yields. Meanwhile, in Asia and emerging markets, risks are naturally higher.
So, for passive investors, the U.S. seems like the simpler choice. BND provides broad exposure to investment-grade American bonds.
There are plenty of bond funds that are more aggressive and potentially could offer higher returns. But few, if any, offer the same peace of mind as BND.
Vanguard Real Estate ETF (VNQ)
The last entry on this list of index funds is another Vanguard option. After all, the company pioneered passive investing and generally offers lower expense ratios. VNQ stock is no exception. Its expense ratio is just 0.12%, against 0.42% for the iShares U.S. Real Estate ETF (NYSEARCA:IYR), for instance.
As the name suggests, VNQ provides attractive exposure to real estate. It does so through the ownership of U.S. real estate investment trusts (REITs). The portfolio spans all end markets, from industrial to residential to health care.
Due to its REIT ownership, VNQ offers income as well. The effective yield, adjusted for return of capital, is a healthy 2.33%. That’s better than the 10-year Treasury bond — and a nice addition to the diversification and low fees this name has to offer.
On the date of publication, Vince Martin held a long position in AMZN.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.