An index investing strategy often appeals to investors who are interested in taking a passive approach to the market. While there are many possibilities, Vanguard index funds are among the most popular options for low-cost investing. These funds, which seek to match the performance of a stock market benchmark rather than beating it, allow for simplified diversification when building a portfolio.
What Are Vanguard Index Funds?
An index fund is a type of mutual fund that’s designed to match or align with the performance of a specific stock market benchmark. For example, there are index funds that track the S&P 500 index and others that follow the Russell 2000 index.
These funds hold all of the stocks, bonds or other securities that its underlying index owns. This is what makes index funds passive since the fund manager isn’t actively buying and selling individual securities. Vanguard offers both index mutual funds as well as exchange-traded funds (ETFs) that follow a passive investment strategy. Exchange-traded funds are similar to mutual funds, but they trade on an exchange like a stock.
Vanguard’s first index fund was created in 1976 by Jack Bogle. This fund, the Vanguard 500 Index Fund Investor Shares (VFINX), tracks the S&P 500 index, which includes the 500 largest companies in the U.S. As of March 2020, Vanguard offers more than 60 index mutual funds and over 70 index exchange-traded funds.
Those options include:
- Stock funds
- Bond funds
- International funds
- Sector and specialty funds
- Balanced funds
- Target-date funds
Balanced funds seek to combine both stocks and bonds together in one fund. Sector and specialty funds focus on a specific stock market sector, such as financials or real estate. Target-date funds adjust their asset allocation automatically, based on a target retirement date. Target-date funds have become an increasingly popular option in 401(k)s and other workplace retirement plans.
How Vanguard Index Funds Work
Vanguard index funds group together investments that represent the index they target. Funds can include a mix of stocks and bonds or focus more heavily on one type of investment than another. For example, the Vanguard Total Bond Market Index Fund (VBTLX) offers investors exposure to the total bond market while the Vanguard Total International Bond Index (VTABX) targets the global bond market.
Regardless of what they invest in, Vanguard index funds have several things in common, including:
- Low investment minimums
- Below industry average expense ratios
- Broad diversification in a simplified package
Index funds by nature tend to be more cost-efficient than other types of mutual funds simply because they’re passively managed. According to Vanguard, their funds have an average expense ratio that’s 73% less than the industry standard. The expense ratio represents the cost of owning an index fund or ETF on a yearly basis, expressed as a percentage of assets.
Vanguard’s index funds allow for easier diversification since you can invest with the goal of matching a specific index. Like other mutual funds, Vanguard funds balance risk with rewards, in that the greater the risk the greater the fund’s return potential may be.
Why Investors Like Index Investing With Vanguard
The main advantages of investing with Vanguard index funds are the costs and the performance of its funds. The lower a fund’s expense ratio, the more of your returns and investment growth you get to keep. Additionally, Vanguard funds that rely on a passive investment strategy can also be cost-friendly from a tax perspective.
In an actively managed fund, the fund manager routinely buys and sells underlying securities to drive fund performance. One side effect of doing so is that when a security is sold at a profit, that results in a capital gain for the fund’s investors. By utilizing a passive investment strategy in which securities are exchanged less often, Vanguard index funds can help investors better manage their tax liability.
Aside from that, Vanguard index funds have a solid track record of performance. For example, for 2019 VFINX returned 31.33% to investors. By comparison, the S&P 500 generated a total return of 31.49%. While it’s not an exact return match, the numbers suggest that VFINX did what it was supposed to do – track the S&P 500’s returns.
Which Vanguard Index Funds Are the Best?
Vanguard offers numerous index fund options, including ETFs, which means investors have the advantage of variety when deciding which ones to invest in. When considering any Vanguard funds, it’s important to look at the expense ratio as well as the fund’s historical performance.
These Vanguard index funds are some of the most popular among investors.
- Vanguard 500 Index Fund Investor Shares (VFINX): The original Vanguard index fund tracks the S&P 500 and offers exposure to large-cap companies. This fund is also available as an ETF, Vanguard S&P 500 ETF (VOO).
- Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX): This fund is designed to provide exposure to the entire stock market, across small-cap, mid-cap and large-cap companies. With an expense ratio of 0.04%, it’s one of Vanguard’s most affordable index funds.
- Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX): This index fund is designed for investors who are looking to add fixed income to their portfolios. The fund invests approximately 30% of assets in corporate bonds, with the remaining 70% held in government bonds of varying maturities.
- Vanguard Total International Stock Index Fund (VTIAX): VTIAX invests in international stocks from both developed and emerging market countries. This fund has high return potential but it can also be more volatile than other index fund options.
- Vanguard Real Estate Index Fund Admiral Shares (VGSLX): This fund invests in real estate investment trusts (REITs), which are legal entities that own investment properties. It may appeal to investors who are comfortable taking on more risk in exchange for dividend income.
How to Invest in Vanguard Index Funds
You can invest with Vanguard by opening an account directly or by setting up an account with an online brokerage that offers Vanguard funds. Since Vanguard funds are already cost-efficient, it might make more sense to hold them in a taxable brokerage account versus an individual retirement account. However, there’s no rule that says you can’t own Vanguard index funds in your IRA.
When choosing funds, check the expense ratio so you know what you’re paying for each fund. Also, consider the minimum initial investment. Most Vanguard index funds set the minimum at $3,000 but some funds may require a large initial buy-in to get started investing. And of course, compare each fund’s risk/reward profile to make sure it aligns with your risk tolerance and investment goals.
The Bottom Line
Vanguard index funds can offer stable and consistent returns with low investment fees for those who prefer passive investing. There are numerous funds to choose from, allowing you to build as complex or as simple a portfolio as you’d like. You can invest in Vanguard funds by opening an account with Vanguard or another brokerage. In some cases, depending on which specific Vanguard fund you’re interested in, other brokerage firms will waive the transaction fee for buying the Vanguard fund; in other cases, they will not waive the transaction fee. You may also find Vanguard index funds as an offering in your workplace retirement plan.
Tips for Investing
- Consider talking to your financial advisor about the merits of index investing. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to connect with local advisors who will help you achieve your financial goals, get started now.
- If you’re considering index investing, it helps to know a little about the various indexes these funds can track. For example, the S&P 500 and the Russell 2000 track different baskets of securities and thus will have different performance. Familiarizing yourself with different indexes can help with choosing funds and ensuring that you’re adding the right amount of diversification to your portfolio.
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