Looking for the top index funds to buy? You’ve come to the right place. After a couple hours of research, I’ve put together this list of top index funds. I started with a few safe-but-boring options, and then went out and bagged progressively weirder stuff.
Wihout further ado…
Vanguard’s Target Date Retirement Funds
When I started Top Financial Advisor, I did so because the subject was so broad. Finance! Money! The global economy! What could be more complex than the global economy? A whole multiverse of possible assets to invest in, debt techniques and psychology to sharpen…
This hasn’t proved to be the case. I mean, sure, everything I said is true. But when it comes to actual advice, I repeat, over and over and forever, recommendations for two products:
There is no simpler, better choice for the lazy investor. (The enterprising investor is welcome to choose differently, but he thrusts himself into a world of infinite complexity.) But, right, I will focus on the target date index funds.
Here’s how they work. You pick one that best corresponds to the date when you wish to retire. Then, the guys over at Vanguard calculate some asset allocation based on that date, and fill it with index funds.
Like Betterment, this is the sort of fund where you can set up some monthly contribution and forget about it until you need to retire. That’s the idea, anyways, and my #1 recommendation.
Vanguard 500 Index Fund
Okay, maybe that last strategy wasn’t for you. You might not trust my recommendations which, you know, stings a little bit, but it’s sort of understandable. At this point in our relationship, I’m just a guy on a blog.
If that’s the case, if I lack the authority to persuade you, let me introduce you to a quote to someone you ought to recognize:
My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s. (VFINX))
That’s right, friends. You heard it from the sage of Ohama himself, Warren Buffet, who recommends that his wife place her money into Vanguard’s VFINX. VINX, by the way, tracks the S&P 500, so it concentrates on large-cap stocks like Apple and Exxon.
Bogleheads, investors, and whatever, they like to use this quote as ammunition, arguing that this proves that their preferred philosophy of investing is the ‘right’ one. I don’t read it this way at all, and anyone with even a passing familiarity with Graham’s, Buffet’s, or Munger’s writings would realize that. Buffet is recommending passive investing for the busy or lazy investor. Not for every investor.
That aside, this is a fine choice for one of your core holdings, and you don’t take have to take my word for it.
Vanguard Small-Cap Value Index Fund
Academic finance has evolved since the heady days of the 1970s. Back then, the capital asset pricing model was du jour. The basic idea: risk and return are two sides of the same coin. For more returns, take on more risk.
There was one, tiny, tiny issue with this idea, though. Experimentally, the relationship didn’t and hasn’t hold up. Very risky stocks have low returns, not high ones.
So PhDs everywhere went searching for other factors to explain returns. Thus, the Fama-French three factor model was born. This model extended the classical CAPM to include two more factors: small cap stocks – those representing small companies – and value stocks, those which are cheap compared to the amount of assets that they hold.
Historically, these two types of stocks, small cap and value, have commanded excess returns. Because of this, many investors “tilt” their portfolios towards these kinds of assets – meaning that they hold more of them percentage-wise than the market does as a whole.
How can you, too, tilt your portfolio to take advatage of this premium, assuming that it will continue to exist? Simple, buy some shares of Vanguard’s Small-Cap Value Index Fund (VISVX).
Vanguard REIT Index Fund
A friend of mine recently bought land out in Colorado. As far as I know, he hasn’t done anything with it yet, although it’s possible that he has plans in motion. Maybe eventually it will earn him some sort of income.
I like productive assets. I don’t like things like commodities or gold, because the underlying assets don’t produce any cashflow. In contrast, a business has earnings. Real estate has rent. Cashflow.
If you do want to invest in real estate, the first notion everyone has, I think, it to buy some property and find renters. This usually turns out okay, and sometimes spectacularly well, like in the case of Arnold Schwarzenegger.
But, supposing you don’t want to go through that hassle, what’s a guy or gal to do? You could invest in a REIT. In the same way that the other funds listed here own small shares of different businesses, REITs own small slices of different properties.
That’s how the Vanguard REIT index fund works.
The risk characteristics of this type of asset are similar to stocks, but can add diversification to a portfolio. Still, I would not allocate more than 10% of my portfolio to a REIT.
iShares MSCI Frontier 100 ETF
There are developed markets, like United States and emerging markets, like India and China. These ought to be familiar to you.
And then there are frontier markets. These are ones you can’t yet call emerging. These are countries like Estonia and Vietnam.
iShares MSCI Frontier 100 ETF tracks these markets. They’re high risk, but with the potential of high return. Who wouldn’t want to have gotten in on China before it was China, you know? Of course, you could always end up getting into something like Argentina, which is still… Argentina, a country so messed up that Bitcoin is a less volatile alternative to their national currency.
Historically, frontier market returns have exceeded both those of developed and emerging markets. Since frontier markets represent only 1% of global market capitalization, even if I were very bullish on such markets, I’d hold less than 5% of a portfolio in one of these indexes.
AQR Style Premia Alternative
AQR has the neatest index funds around. They dive deep into the academic literature and spit out weird concoctions with the hope that these will realize excess returns.
Of these, my favorite is their “Style Premia Alternative” fund. It attempts to capture excess returns by focusing on four factors:
- Value: You’ll remember this from what I wrote about Small-Cap Value Index Funds. The Value premium is the historical tendency of cheap stocks to outperform expensive, or growth, stocks.
- Momentum: The idea here is similar to Newton’s second law, inertia. Just as a body in motion tends to stay in motion, a stock on the rise or fall tends to stay on the rise or fall.
- Carry: I’m not exactly sure what factor they’re exploiting here, but perhaps it has something to do with what I’ve been calling assets-that-produce-cashflow.
- Defensive: I mentioned earlier that empirically risky assets have not outperformed low-risk ones. In fact, the opposite. The fund attempts to exploit this value.
This fund is interesting. I would like to have invented it myself, and I would probably own some of it, except that the total annual fees on it are 2.11% (!). This is highway robbery, and I’m not at all confident that the value-add here is going to be enough to make up for it.
Market Vectors Mstar Wide Moat
Ah, and finally, that brings us to my last index fund, although as I’ve progressed through these, they’ve started to look less and less like traditional indexes and more like actively managed funds. This one is no exception.
The basic idea of Morningstar’s MOAT fund is to buy shares of quality businesses and short shares of poor businesses. Quality businesses are those that have a wide-economic moat, a concept popularized by Warren Buffet. A moat is a durable competitive advantage.
Consider, for instance, Coca Cola, one of both Buffet’s and MOAT’s holdings. Coca Cola’s durable competitive advantage is that its product isn’t fungible. Trust me. I’ve spoken to waiters at places that only serve Pepsi products. For most people, the two are emphatically not the same.
That’s Coke’s moat. Consumers are not willing to switch from it to another product, so you can have a pretty high degree of certainty that Coca Cola is going to be around for a while.
Now, the analysts over at Morningstar have a more complicated model for capturing this basic idea, but that’s the gist of it.
Most interesting about Morningstar’s MOAT fund, though, is that it only holds about 20 assets. This means that you can pretty trivially buy some of the stocks it holds for yourself. Or even all of them. You could create a DIY fund, but without the fees.
How the taxes on such a thing would turn out, I don’t know but, still, that’s kinda neat.
Putting It All Together
So, those are my 7 top index funds, or at least 7 interesting index funds. They’re ranked in roughly descending order of where I think you ought to actually put your money–my top recommendation is going with either one of Vanguard’s target date funds or Betterment.
If you’re more inclined to do-it-yourself, you could do something like combining a core holding of the next fund I mentioned, Vanguard 500 Index Fund, with some others, like the Small-Cap value fund or the frontier markets fund. You’ll probably want some international market and bonds in there, too. Maybe even a REIT.
The last two are more sorta interesting than anything I’d really recommend putting money into.
If you are leaning towards any of these, here’s the best recommendation I’ve got: do your research. Do the due diligence. No one cares as much about your money as you do.