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6 Vanguard Index Funds to Buy and Hold Forever

Just six index funds from fund giant Vanguard can boost your returns. But, which six?

Kiplinger

Some people, including me, love to study the ins and outs of investments. Fortunately for those who don’t, investing for retirement can be remarkably simple. If you’re looking for a simple yet first-class investment plan, this article is for you.

See Also: Best Funds for Dividends Other Than Vanguard Dividend Growth

Index funds—funds that track an investment benchmark rather than trying to beat it—aren’t perfect. But unless you’re an investment hobbyist or you work with an adviser, there’s simply no reason not to invest in them. That said, there are thousands to choose from. This article will tell you which index funds to own and how much to invest in each.

The numbers don’t lie: Over the past ten years, less than 30% of U.S. actively managed stock funds outmatched their benchmark indexes. What’s more, it’s devilishly tricky to pick funds that will outperform index funds. You certainly can’t do it by looking at past returns.

Why is it so hard for actively managed funds to beat their benchmarks? Professionals, virtually all of whom strive to beat an index, dominate the investment world nowadays. They obviously can’t all be winners. And the statistics are quite clear: Funds, on average, trail their benchmarks by precisely the amount of their expense ratios. Actively managed domestic funds, on average, charge 1.2% annually; you can buy index funds charging a small fraction of that price.

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What’s even more important is that index funds, in my view, are easier to stick with, and that can boost your returns in the long run. Actively managed funds, by definition, don’t track an index precisely, so even the best actively managed funds have periods when they trail their benchmark, often by a large amount. Investors tend to jump from active funds with recent punk returns to funds that have been hot lately. That path guarantees lousy long-term returns. Statistics compiled by Morningstar show that investor fund returns, on the whole, trail those of the funds they invest in by 1.3% annually. Index funds, meanwhile, should always deliver their index’s returns, minus their generally tiny expense ratios, so there’s less temptation to fund-hop.

Vanguard is the best shop for index funds. Founder Jack Bogle first popularized index fund investing, launching Vanguard’s Standard & Poor’s 500-stock index fund in 1976. The firm is owned by its fund shareholders, meaning it’s essentially a nonprofit. Consequently, its fees are among the industry’s lowest. Unlike most competitors, moreover, it has long been committed to low fees. That means fees are unlikely to rise when investors aren’t paying attention.

Below are the six index funds I recommend, as well as the percentages of each you should own. For each, I’ve listed the symbol and annual expense ratio for the exchange-traded version of the fund. You can get the same low expense ratio by investing in the Admiral share class of the corresponding traditional mutual fund, which generally requires a high initial minimum investment. The Investor shares cost a bit more.

Put 30% of your investment dollars in Vanguard 500 ETF (symbol VOO), which invests mainly in stocks of large U.S. companies but also has about 15% of its assets in midsize stocks. The ETF costs just 0.05% annually. Standard & Poor’s 500-stock index is a capitalization-weighted index, meaning the stocks with largest market values (share price times number of shares outstanding) are the largest holdings in the index. So, Apple (AAPL), with a market cap of $622 billion, is the biggest holding in the index at over 3% of assets.

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Midsize stocks have achieved better risk-adjusted returns than either large- or small-cap stocks since 1926. Vanguard S&P Mid-Cap 400 ETF (IVOO) charges 0.15% annually. The index has an average market capitalization of about $4.2 billion. S&P excludes some financially troubled companies from this index, which has given it a small advantage over other mid-cap indexes. Invest 10% of your assets here.

Small-cap stocks are inherently riskier than larger stocks, but, over the long term, they’ve produced the best returns. Put 10% of your portfolio in Vanguard S&P Small Cap 600 ETF (VIOO). The average stock in the index has a market cap of about $1.3 billion. S&P’s winnowing out of financially weak companies has provided this index a noticeable edge over its competitors.

Foreign stocks have stunk in recent years, but history tells us that over time they’ll bounce back. Put 15% of assets in Vanguard FTSE Developed Markets Index ETF (VEA), which charges just 0.09% annually to invest in foreign developed markets, mainly in Europe and Japan.

Fans of emerging markets, and I include myself as one, have had their patience tested in recent years. Vanguard FTSE Emerging Markets Index ETF (VWO) returned a meager annualized 1.6% over the past five years. And that includes a 12.2% gain in 2016. But over the long haul, patience will be rewarded. Put 10% of your investment money here. The ETF charges 0.15% annually.

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For bonds, look to Vanguard Short-Term Corporate Bond ETF (VCSH), which charges just 0.07% annually. The average credit quality of its bonds is single-A. Should rates rise by one percentage point, the fund’s price should drop by less than 3%. This is a very conservative fund that I think will be appropriate in the coming years. Put 25% of your investments here.

This 75% stock, 25% bond mix is a good one for investors 15 or more years from retirement. Remember to rebalance every year or so if the market’s action gets your initial investment allocation out of whack. When you’re within 15 years of retirement, trim your stock ETFs by five percentage points and add that cash to the bond ETF. Repeat that maneuver every five years, until you have about 60% in stocks and 40% in bonds, which is a good allocation for the early and middle years of retirement.

Steve Goldberg is an investment adviser in the Washington, D.C., area.

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