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6 Best Vanguard Index Funds for 2018 and Beyond

Steven Goldberg, Contributing Columnist, Kiplinger.com
You can build a well-balanced portfolio with just six mutual funds--but which six and how much should you invest in each?

I've spent a good portion of my waking hours over the past 25 years studying mutual funds both as a writer for Kiplinger's and for the past 10 years as an investment advisor. I find investing endlessly fascinating. But if you don't enjoy poring over mutual fund statistics, and you don't want to pay an advisor to do the heavy lifting for you, this article gives you all the information you need to implement and maintain a first-class investment plan.

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The key is leaning on Vanguard index funds. Rather than trying to beat a market benchmark, index funds strive to mirror the performance of the indexes they track. They quite simply dare to be average. And by being average, low-cost index funds, such as Vanguard's, are virtually guaranteed to beat the average fund.

Actively managed mutual funds employ managers and analysts in an effort to outpace an index, at least on a risk-adjusted basis. That costs money; so active funds charge investors higher fees than index funds. The average actively managed domestic fund charges 1.2% annually in expenses; the weighted average of the index funds recommended here cost less than 0.08% annually. On a $100,000 investment, you'd pay Vanguard $80 a year for the index portfolio. By contrast, with an average active fund, you'd pay $1,200.

And guess what? The average actively managed fund trails its benchmark by an average of just about one percentage point per year, and less than one-third of active funds top their benchmark indexes. It's not that the fund managers are dumb; it's just that they're all playing the same game. Common sense tells you the average fund should lag its index by its expense ratio.

What are the best Vanguard index funds?

Below are the only six index funds you need to achieve investment success together with the percentage I recommend investing in each. All the picks are from Vanguard because Vanguard has the most experience with index funds and charges among the lowest prices in the industry. For each index mutual fund, I've listed the symbol for the Admiral share class, which has a higher minimum investment but a lower expense ratio than Vanguard's investor shares. I've also listed the symbols for the equivalent Vanguard exchange-traded funds, which have similarly low expense ratios. Finally, I've recommended the percentage of your portfolio to invest in each fund.

Start with Vanguard Total Stock Market Index (symbol VTSAX; 40% of your portfolio). This mutual fund gives you the entire U.S. stock market for the tiny expense ratio of 0.04% annually. VTSAX tracks the CRSP U.S. Total Market Index. Most of its assets are in stocks of large companies, but about 28% of assets are in small and midsize stocks. ETF alternative: Vanguard Total Stock Market ETF (VTI).

Over the long term, stocks of small and midsize companies have outpointed larger companies. Vanguard S&P Mid-Cap 400 Index (VSPMX; 10%) gives you midsize stocks at an expense ratio of 0.08% annually. Standard & Poor's excludes some of the most financially troubled companies from the index, and this very light-touch screening has paid off for investors. One negative: VSPMX comes with a $5 million minimum unless you buy it through an online broker or workplace retirement account. An alternative mutual fund with a lower minimum is Vanguard Mid Cap Index Admiral (VIMAX), which tracks the CRSP U.S. Mid Cap index. ETF alternative: Vanguard S&P Mid-Cap 400 ETF (IVOO).

For small caps, look to Vanguard S&P Small-Cap 600 Index (VSMSX; 5%), which charges 0.08% annually. Like its mid-cap sibling, VSMSX comes with a $5 million minimum. An alternative fund is Vanguard Small-Cap Index (VSMAX), which tracks the CRSP U.S. Small Cap index. Expenses are 0.06% annually, but the fund lacks the S&P screening. ETF alternative: Vanguard S&P Small-Cap 600 ETF (VIOO).

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Don't ignore the rest of the world. Vanguard Developed Markets Index (VTMGX; 15%) tracks the FTSE developed All Cap ex US index for 0.07% annually. The mutual fund gives you broad exposure to Europe, Japan, Canada, Australia and other developed markets. Foreign stocks have rebounded nicely in 2017 after producing pitiful returns over the previous 10 years. Foreign and U.S. stocks have traditionally taken turns beating each other for multi-year periods. ETF alternative: Vanguard FTSE Developed Markets ETF (VEA).

Emerging markets were also stinkers over the 10 years through 2016 but have blossomed in 2017. Yes, they're risky, but they're also the fastest growing portions of the global economy. Vanguard Emerging Markets Stock Index (VEMAX; 10%) has 32% of assets in China and 71% in all of Asia. The mutual fund also has substantial holdings in Eastern Europe, Latin America and South Africa. Annual expenses are 0.14%. ETF alternative: Vanguard FTSE Emerging Markets ETF (VWO).

Finally, you need a bond fund--not so much for the yield, but as ballast for the stock market's periodic belly flops. Vanguard Short-Term Corporate Bond Index (VSCSX; 20%) charges 0.07% to invest in short-term, investment-grade bonds. Five years from now, I'd probably recommend an intermediate-term bond fund. But with a 2.5% yield and short bond maturities, VSCSX is much safer for now--and, I believe, for years to come. ETF alternative: Vanguard Short-Term Corporate Bond ETF (VCSH).

For investors more than 15 years from retirement, the mix of 80% stocks and 20% bonds I recommend above is a good allocation. Remember to rebalance your holdings every year or so. When you're 15 years from retirement trim your stock fund allocation 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. That's a good stock allocation for most people in the early and middle years of retirement.

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

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