If You Invest in ONE Index Fund, Make it This One
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What is the ONE index fund investors should be buying right now?
In this video, I’ll reveal four index funds to watch and the one fund to buy that will give you the perfect combination of market returns and low price. I’ll also explain index fund investing and why every investor needs at least one fund. Then I’ll show you exactly what to look for before you buy!
We’ll be covering all the strategies here from value investing to growth, tech, index funds and by the end of the series, you’ll have a portfolio of the very best stocks to buy! Make sure you join the community, tap that subscribe button so you don’t miss any of these because it’s going to be a complete portfolio of the best stocks.
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I want to get right into that list of the best index funds so we’ll save for later why every investor needs an index fund in their portfolio and the three things you absolutely must look for when you’re buying a fund.
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4 Index Funds to Buy for Perfect Market Returns and Low Price
First up, is two of the most widely held index funds; the SPDR S&P 500 Trust, ticker SPY, or the Vanguard 500 Index Fund, ticker VOO.
These are basically the same fund because they track the S&P 500 index so closely, here in this chart with the two funds and the index, but I prefer the Vanguard fund and I’ll tell you why when we look at what to look for in an index fund later.
The Vanguard fund covers the S&P 500 which means it holds the 500 largest companies in the United States, titans like Apple, Microsoft and Amazon. It also means, just like the index, it’s got a fourth of the assets in tech stocks, and 64% of the fund is in just four sectors, so not quite as spread out as I’d like.
The fund pays a 1.62% dividend yield and charges a super low expense ratio of just 0.03%…that’s basically nothing, just $0.30 a year for every $1000 you have invested.
The problem here is there’s also a lot missing from the VOO and any S&P 500 index fund. It holds those 500 largest companies but has no exposure to small cap companies or many of the growth stocks that have helped the Nasdaq outperform over the last few years. It also doesn’t have international stocks. The $40 trillion market cap for the S&P 500 companies is nearly half the total $93 trillion market value of all global stocks but it does leave a lot out.
We’ve still got four more index funds to highlight including the top pick but I want to explain these because I know there are a lot of misconceptions out there. An index fund is a group of investments bundled together and then shares of the entire group are sold to investors. Buying a share of the fund means you get the returns on everything in the group instead of having to buy hundreds or thousands of stocks separately and for this, you pay a percentage fee to the manager.
Now this might sound a lot like an exchange traded fund, an ETF, and it’s because index funds are sold as ETFs or mutual funds. You buy them just like stocks and most you can buy with no commission.
Where the confusion sets in is, not all ETFs are index funds. You see, index funds invest in a broad benchmark group like the S&P 500 or the Nasdaq. The manager just replicates the index, so they’re investing passively and have no control over what goes into the fund. That’s different from a lot of theme ETFs like for example the Vanguard High Dividend Yield Fund, ticker VYM, which I like but is NOT a true index fund. The VYM like other non-index funds bases its investments off a strategy or a theme, in this case companies that pay above-average dividend yields.
By comparison, the S&P 500 is a broad stock market index, the Nasdaq 100 is a broad index of the 100 largest non-financial companies listed on the exchange, so more broadly defined and inclusive of all stocks in the group.
Why Every Investor Needs an Index Fund in Their Portfolio
OK, by now I know half of you are screaming Get On With It Already…but the difference is hugely important and why every investor needs an index fund in their portfolio.
Buying an index fund means you get that broad market exposure; you are the market and you know you’ll get all the diversification and return you can only get from the entire market. Theme ETFs in dividends or growth or value stocks are great and I’m planning a video on those as well but investors don’t realize what they’re missing.
Let’s look at that Vanguard Dividend Fund, the VYM, versus a true index fund the SPDR S&P Trust, the SPY. The VYM holds almost 500 stocks so you’d think your risk is spread out really well but if you look at the weight of each sector in the fund, the picture starts to change. The stocks in just four sectors; Consumer Staples, Energy, Financials and Healthcare make up more than 57% of the fund. Just four of the 11 sectors of the economy are more than half the fund.
And when you compare the stocks in the VYM with those in the S&P 500, what most people use as the benchmark for the stock market, it’s a completely different picture. For example, more than 27% of the S&P 500 index is tech stocks while the group only makes up 6.9% of the VYM ETF. Energy stocks make up 10% of the dividend fund, more than twice the exposure in the overall market.
And this isn’t to say the VYM or other theme ETFs are not good investments. They are and I’ll show you which to buy in that other video, but you are not getting that broad market exposure and the risk reduction that you can only get with a true index fund.
Where the S&P Index funds were missing growth stocks, the Invesco QQQ Trust, has all the growth you need tracking the Nasdaq 100 index.
The fund invests in the 100 largest non-financial companies in the Nasdaq index, and there is some overlap with S&P companies but it’s much more focused on Tech. That’s more obvious when you look at the sector weightings with tech stocks making up half of the portfolio and just the top three sectors making up 84% of assets.
The dividend yield is only 0.74% but that focus on growth has helped it nearly double the return on the S&P 500 over the last five years even though the fund is a little more expensive at 0.2% a year.
But just like the S&P index funds, there’s still a lot missing here. That focus on growth comes at a cost. Because half the fund is in tech stocks, it falls harder in a crash with the QQQ down 30% this year versus just 20% for the S&P 500. Just like the S&P fund, it also lacks any exposure to smaller companies and international stocks.
One type of asset we haven’t talked about, bonds and the Vanguard Total Bond Market Index, ticker BND.
And before I get all kinds of hate comments about bonds being shit this year…the BND is only down 9% including the dividend so even in that selloff on rates, it has protected your money from a lot of the market crash.
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The fund invests across quality U.S. dollar-denominated bonds including government, domestic and even international exposure with more than 10,000 bonds in the portfolio. It pays a solid 3.4% dividend yield and gives you exposure to the entire asset class for a little safety outside of stocks.
Of course, this wouldn’t be the only index fund you want because you’d miss out on the growth that comes from stocks but it is a good addition to a portfolio. It also doesn’t have high-yield bonds which are lower credit quality but higher return or any exposure to other asset classes like real estate or commodities.
Two more index funds to watch but all you out there in the Nation know, I’m not just about dropping a list of stocks in your lap and saying go buy these. I want to show you what to look for in an index fund, how to find these investments on your own.
3 Things You Must Look for When Buying Index Fund
For that, it all comes down to three simple things you want to look for and compare to find the best index fund for your portfolio.
First, you want an index fund that is as broad as possible, one that covers the entire market. This is your chance to BE the market, not have to worry about picking that one stock out of the 4000 traded in the U.S. market. Even better, there are funds that will give you exposure to international stocks as well.
You also want a fund that isn’t going to duplicate too much of your other ETFs or stocks. This is why I say, the best fund for YOUR portfolio, because that might be different from the best fund for my portfolio or someone else’s. For example, if you already own something like the Nasdaq 100 Covered Call ETF, the QYLD, then adding the Nasdaq index ETF, that QQQ, is going to just double-up your exposure to tech stocks.
It's usually not so much a problem with individual stocks because most index funds only have a few percent in each stock but if you own a theme ETF that invests narrowly in a group of stocks, just make sure it’s not the same group that’s in your index fund. You can always see exactly what stocks are in an index fund or ETF by going to its website and looking for either holdings or portfolio. This will show you the stocks as well as the sector breakdowns for the fund.
And something you want to do for all ETFs or funds before you invest, check that expense ratio! This is the annual percentage fee charged by the fund manager and the lower the better. Most index funds charge very low fees because they’re passively managed, the fund manager just buys what’s in the index so there isn’t much analysis to do. For example, the fund I’ll show you next charges 0.07% which would mean just $0.70 for every $1000 invested! It’s more important on the theme ETFs because these can get really expensive like the 0.75% expense fee on the ARK Invest Funds.
This is also why I prefer the Vanguard S&P fund, the VOO, against the SPY because of the expense ratio. The SPY charges 0.09% while the VOO is just 0.03% and while that’s only a difference of $6 for every $10,000 invested…it’s the exact same investment so I’ll take my $6 and buy an extra mocha-cocoa-cappuccino!
This next index fund, the Vanguard Developed Markets ETF, ticker VEA, gives you access to another part of the market most investors are lacking.
The fund invests in a diversified mix of small-, mid and large-cap companies across the developed world including Canada, Europe and the Pacific. There’s more than 4,100 companies here and some of the most recognizable brands including Nestle, Samsung and Toyota.
The fund pays a 2.5% dividend yield, well above what you get on the S&P 500, and provides that exposure to international stocks in an easy all-in-one package. It’s down 18% so far this year, slightly less than the U.S. market, so providing a little protection in that international diversification.
But even with 4100 stocks, there’s still some parts of the market missing from the fund. First, it doesn’t hold any U.S. stocks so you’d need to pair it with an S&P fund like the VOO. It also doesn’t hold any emerging market stocks or other asset classes like bonds.
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Next I’ll reveal the best index fund for your money, the one that has it all, but don’t forget to catch the first video in our one stock series, the value stock with a 60%-plus upside potential. I also want to get your input on this though, what other themes do you want to see covered in our one stock series? I’m planning one for ETFs, growth stocks and penny stocks but let me know in the comments, what theme or investing strategy do you want to see.
The broadest, most inclusive index fund you can buy, the Vanguard Total World Stock Fund, ticker VT.
The Total World index gives you everything in the S&P 500 and the VEA but also emerging markets and smaller companies. You’ve got small caps, large caps, developed, emerging and U.S. stocks. Looking at the top 10, it seems to be just a rehash of U.S. stocks but with almost 9500 stocks in this fund, it’s pretty much everything!
The dividend yield isn’t spectacular but does pay 1.65% and the fund has produced a 9% annual return over the last decade for an expense ratio of just 0.07% annually.
Now even a total market index can’t give you everything. The fund lacks that exposure to other asset classes like bonds though it does have real estate stocks in it. You will notice a lot of overlap with the S&P 500 funds so you don’t need the two together.
Check Out the Entire Just One Stock Series
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