Investing in the stock market can appear daunting, but it doesn't have to be. Technology and modern online brokers have made it easier, cheaper, and faster now more than ever for DIY investors to create a simple and effective portfolio. Index funds allow you to make an initial investment and then sit back, relax, and watch your portfolio grow. Here we'll look at the best index funds for beginners and their corresponding ETFs.
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In a hurry? Here's the list:
- SPY – SPDR® S&P 500 ETF Trust
- VOO – Vanguard S&P 500 ETF
- VTI – Vanguard Total Stock Market ETF
- VT – Vanguard Total World Stock ETF
- VXUS – Vanguard Total International Stock ETF
- BND – Vanguard Total Bond Market ETF
Prefer video? Watch it here:
Introduction – What Beginners Should Look For in an Index Fund
If you're looking for index funds, chances are you already know index investing is superior to stock picking over the long-term, and most active managers and traders underperform the market. Jack Bogle, the founder of Vanguard and considered the father of index investing, preached “the majesty of simplicity” that index investing allows, making them especially attractive for beginner, novice investors.
Broadly speaking, index funds usually refer to a fully diversified index across multiple (or all) sectors (Tech, Utilities, Financial, etc.) and cap sizes (small, mid, large) of a particular asset type, or even across multiple asset types (stocks, bonds, etc.). On the other end of the spectrum exist narrowly-focused ETF's with ad hoc “indexes,” e.g. an ETF for artificial intelligence and robotics. Since we're talking about beginner investors with a long-term approach, here we'll focus more on the former, while also seeking out:
- low fees
- broad diversification
- growth potential
- ETF's (Exchange Traded Funds) over mutual funds
Let's dive into the 6 best index funds for beginners.
SPY – SPDR® S&P 500 ETF Trust
SPY is the most highly traded ETF. Launched in 1993, SPY is the ticker for the SPDR® S&P 500 ETF Trust. It tracks the famous S&P 500 index, which is comprised of the 500 largest companies in the U.S. by market cap. The S&P 500 index is what is referred to as “the market,” as it roughly approximates the entire U.S. stock market and is diversified across all sectors. This increased diversification provided by holding 500 companies decreases portfolio risk and volatility. That is, SPY can be your entire portfolio, as least for most of your investing horizon until you want to add other asset types like bonds or metals.
SPY has an expense ratio of 0.09%.
VOO – Vanguard S&P 500 ETF
VOO is just Vanguard's ETF to track the S&P 500 index. Think of it as a cheaper SPY. At the time of writing, VOO has an expense ratio of 0.03%, compared to 0.09% for SPY. I usually prefer Vanguard funds for that reason.
VTI – Vanguard Total Stock Market ETF
Prefer to get some exposure to small- and medium-sized companies? You might prefer VTI, Vanguard's offering for the total U.S. stock market. VTI seeks to track the performance of the CRSP US Total Market Index.
VTI includes VOO; that is, VOO comprises about 82% of VTI by weight. The other 18% in VTI is made up of small- and mid-caps. Small- and mid-cap stocks have outperformed large-cap stocks historically, but have suffered in recent years. Because they are more volatile than large-cap stocks, VTI will likely be slightly more volatile than VOO. VTI holds about 3,500 stocks, compared to 500 for VOO. Like VOO, VTI has an expense ratio of 0.03%.
VT – Vanguard Total World Stock ETF
We can go one step further and add in international (ex-US) stocks by using Vanguard's Total World Stock ETF. This ETF tracks the FTSE Global All Cap Index. This gets you diversified globally with stocks. At their market weight, U.S. stocks account for roughly half of the global stock market. So basically, about 50% of VT is VTI.
Most U.S. investors have what's called home country bias, preferring to invest in U.S. stocks, and rightfully so. But it's important to note that international stocks offer a diversification benefit because they do not move in perfect lockstep with U.S. stocks, thereby lowering portfolio volatility and risk. During the period 1970 to 2008, a stocks portfolio of 80% U.S. stocks and 20% international stocks had higher general and risk-adjusted returns than a 100% U.S. stocks portfolio.
VT has an expense ratio of 0.07%.
VXUS – Vanguard Total International Stock ETF
Prefer to dial in your international stock allocation manually? You can do so with VXUS, the Vanguard Total International Stock ETF, which seeks to track the FTSE Global All Cap ex US Index. In other words, this ETF is composed of all stocks outside the United States. One might opt to build their 100% stocks portfolio using 80% VTI and 20% VXUS. VXUS allows beginners to avoid having to choose between Developed and Emerging markets, since the ETF contains both.
VXUS has an expense ratio of 0.07%.
BND – Vanguard Total Bond Market ETF
If you have a low risk tolerance or a short time horizon, you'll probably want some bonds in your portfolio. Bonds offer a fairly reliable negative correlation to stocks, meaning when stocks go down, bonds tend to go up. Because of this, bonds can drastically lower a portfolio's volatility and risk. A popular asset allocation is 60% stocks and 40% bonds, known as the 60/40 Portfolio.
Vanguard's Total Bond Market ETF is a great choice, allowing broad diversification across the U.S. bond market. This ETF seeks to replicate a market-weighted U.S. bond index, containing both government/treasury and corporate bonds. With BND, beginners don't have to worry about choosing a specific bond type or duration.
Adding BND to our previous example with VTI and VXUS results in what's called the Bogleheads 3 Fund Portfolio. At the time of writing, BND has an expense ratio of 0.03%.
Where to Buy These Index Funds
M1 Finance is a great choice of broker to buy the aforementioned index funds. It has zero transaction fees and offers fractional shares, dynamic rebalancing, and a modern, user-friendly interface and mobile app. I wrote a comprehensive review of M1 Finance here.
Disclosure: I am long VOO in my own portfolio.
Disclaimer: While I love diving into investing-related data and playing around with backtests, this is not financial advice, investing advice, or tax advice. The information on this website is for informational, educational, and entertainment purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. I always attempt to ensure the accuracy of information presented but that accuracy cannot be guaranteed. Do your own due diligence. I mention M1 Finance a lot around here. M1 does not provide investment advice, and this is not an offer or solicitation of an offer, or advice to buy or sell any security, and you are encouraged to consult your personal investment, legal, and tax advisors. All examples above are hypothetical, do not reflect any specific investments, are for informational purposes only, and should not be considered an offer to buy or sell any products. All investing involves risk, including the risk of losing the money you invest. Past performance does not guarantee future results. Opinions are my own and do not represent those of other parties mentioned. Read my lengthier disclaimer here.
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