The Complete Guide to Vanguard Index Funds
Index funds are like cheating. And the Vanguard Index Funds are the best around.
You get more while paying less. Your money grows faster than doing it yourself or using professional managers. The fees are also crazy low, so low that you won’t even notice them.
Better performance at a lower price. It’s one of the situations where paying more doesn’t get you a better result.
And Vanguard’s corporate structure is set up so that the fund investors are the owners. That’s you. All fund profits get returned to fund shareholders as lower fees. You never have to worry about getting gouged.
What Is a Vanguard Index Fund?
A Vanguard Index Fund is comprised of hundreds of stocks and/or bonds. The goal isn’t to pick a few “winners” and beat the market. The goal is to get as much diversification as possible in order to match the market.
While a managed fund may individually choose stocks, index funds invest in most of the funds in a specific index (ie., S&P 500, Dow Jones, Nasdaq).
When you purchase shares of an index fund, you’re basically buying into that market as a whole. Having shares in a Vanguard US stock index fund is like having shares in the entire US stock market. You own a little bit of everything instead of owning shares in a single company.
Index funds also tend to have lower taxes since they don’t buy or sell frequently like managed funds. Index funds also cost less than managed funds because there’s less time spent hand-picking stocks and bonds.
How do the index funds work?
When building a stock index fund, Vanguard purchases shares from a ton of different companies. Vanguard’s goal is to match their ownership of a given company to that company’s share of the overall market.
For example, let’s say a Vanguard fund has $100 to invest and that Amazon represents about 10% of the entire stock market. In this case, Vanguard would invest $10 into Amazon and the remaining $90 into other companies. If Amazon’s value grows, Vanguard buys more. If it shrinks, Vanguard buys less.
Then when you buy shares in that index fund, you have a claim to a small percentage of all those investments that Vanguard makes on your behalf. When those companies give dividends, you get your cut. And as the value of the market grows or shrinks, the value of your investment changes with it.
This is how index funds work across all their respective markets: stocks, bonds, real-estate, international stocks and bonds, etc. Vanguard has 80 index exchange-traded funds and more than 60 main index funds from which to choose. Each of them tracks their respective market as closely as possible.
Our Take on Vanguard Index Funds
Vanguard is an excellent option for index funds. They started the index fund revolution and set the standard for the entire industry. Compared to index funds from other firms, Vanguard either has the lowest fees or comes really close.
They do have one major downside: most of their funds require at least a $3,000 deposit to get started.
In the past, the lowest fees from their Admiral Funds didn’t open up until you had $10,000 invested. Vanguard did eliminate this restriction and now offers their lowest fees at the $3,000 minimum. It’s a good example of Vanguard always looking for ways to reduce their fees.
For first time investors, $3,000 is still a steep requirement. Many index funds at other firms don’t have any minimums, you could start with an investment of $10 if you wanted to.
When I was starting, I saved up $3,000 in order to open up my first Vanguard investment fund. That’s one option.
But if the $3,000 minimum is too steep, I’d go with another firm.
The Cost and How to Buy Vanguard Index Fund Shares
Every index fund has an expense ratio, it’s a percentage that the fund charges you every year based on your total investment in that fund.
Most of the Vanguard index funds have an expense ratio in the 0.04% to 0.15% range. As a rough rule, simple index funds like total stock or bond indexes are on the lower end and more complicated markets like precious metals will have higher fees. It wasn’t that long ago that mutual funds would charge 1-2% so these expense ratios are super low.
Vanguard does technically have an annual service fee of $20 per account. There’s two ways to avoid this fee:
- Have at least $10,000 in the account
- Agree to electronic delivery for all documents
Since electronic documents are almost always easier, most folks can easily get the fee waived. So all you have to worry about is the expense ratio on your funds. Everything else is free. That includes buying and selling Vanguard index funds.
A list of Vanguard’s fees is here.
The Best Vanguard Index Funds
Vanguard has dozens of index fund options to choose from.
If I had to pick only four index funds to invest in for the rest of my life, it would be these four. They have the best combination of:
- Low fees
- Diversification across asset classes
For most folks, these are the only index funds you really need. You could easily build an entire retirement around just these funds.
- Vanguard Total Stock Market Index Fund (VTSMX): The Total Stock Market Index Fund puts investors in the middle of the US. equity market. The fund covers all ranges of investments from small to large-cap and value stocks. Overall stock market volatility is the biggest risk here.
- Vanguard Total International Stock Index (VTIAX): The VTIAX gives investors exposure to international stock markets which tend to have a low correlation with US stock performance which makes it a great option for diversification. The index focuses on both emerging and developed markets.
- Vanguard Total Bond Market Index Fund (VBMFX): This index fund invests 30% in corporate bonds and 70% in U.S. government bonds over a range of short, mid, and long-term levels. This fund invests in all areas of the fixed-income market. It’s a great option for getting full exposure to the US bond market.
- Vanguard Total International Bond Index Fund (VTABX): The VTABX exposes investors to non-U.S. investment-grade bonds. This fund focuses on governments, corporate securities, and international agencies. The fund is a mix of developed and emerging countries.
The Lazy Portfolio of Vanguard Index Funds
If the idea of scouring the list of stock prices makes your head hurt, you could choose a lazy portfolio option. A lazy portfolio option is exactly what it sounds like: investing with minimal effort.
There are a few ways you can do this.
With a two-fund portfolio, you split your investment between stocks and bonds, a popular option is the 60/40 split.
By allocating 60% of your investment towards stocks and 40% towards bonds, you put some money at risk for bigger returns while protecting the rest of your investment in bonds which tend to be less risky. If you went this route, you’d have an entire portfolio with just the VTSMX and VBMFX funds.
For the three-fund lazy portfolio, you divide your investments between stocks, international stocks, and bonds. If you follow the 60/40 rule for this type of investment, you would split the 60% stock investment between U.S. based stocks and international stocks, with the remaining 40% in bonds.
Finally, in a four-fund portfolio, you divide your total investment into four parts: U.S. stocks, small-cap U.S. stocks, international stocks, and bonds. Alternatively, you could factor in international bonds over one of the stock options.
Here’s the split that I use:
- 80% in stocks, 20% in bonds.
- Of the stock portion, 70% in US stocks, 30% in international stocks.
That’s a super simple yet very effective three-fund lazy portfolio. It requires almost no effort to maintain and has gotten me a handsome 10% annual return during the decade-long bull market that we’ve had.
In general, weight more heavily towards stocks when you’re younger. Then weight more heavily towards bonds as you get close to retirement.
We go into more detail on the lazy portfolio here.
Other Options For Index Funds
While Vanguard is the oldest and most well-known company that provides index funds, there are many companies that offer index funds.
Before you choose a company to work with considering the following:
- Does this company offer the type of funds I want or need?
- What are the annual fees like?
- Are there other service or trading fees?
- Do I prefer to keep my accounts consolidated at a single bank?
- How much is the minimum investment required for each fund?
- Do I need to have an account minimum to maintain a brokerage account with certain companies?
Other index fund options include Schwab, Fidelity, and TD Ameritrade. All three are great options with solid reputations.