Vanguard's Best Index Funds

When it comes to indexing, few fund companies have the market presence of Vanguard. Offering more than 70 different index mutual funds and exchange-traded funds, Vanguard is a virtual one-stop shop for fans of passive indexing. But with so many options, how do investors know which index funds are right for them? I took a magnifying glass to Vanguard's offerings and plucked out the best of the best.

The core of your portfolio
Of course, if you're discussing Vanguard index funds, the venerable Vanguard 500 Index Fund (VFINX) may come first to mind. It's now the second-largest mutual fund in existence, with more than $120 billion in net assets. If you want exposure to the market's large caps, including companies like Microsoft (Nasdaq: MSFT  ) , Cisco Systems (Nasdaq: CSCO  ) , and Wal-Mart (NYSE: WMT  ) , this fund is one of the best places to get it. The Vanguard 500 Index fund has tracked the performance of the S&P 500 Index very closely throughout its history, typically trailing by no less than the fund's expenses, just as we'd expect from an index fund. And with a 0.18% expense ratio, it's one of the cheapest ways to buy into the market. If you're looking for a broad market index, this one gets the job done.

On the smaller side
Of course, the 500 Index won't give you any exposure to the smaller end of the capitalization spectrum, so it makes sense to stock up on a fund that will. In this case, your best bet is the Vanguard Small-Cap Index (NAESX). It offers a low-cost entry point for buying smaller companies such as Agere Systems (NYSE: AGR  ) and Cytyc Corporation (Nasdaq: CYTC  ) . Investors should be aware that this fund no longer tracks the Russell 2000 Index, but rather the MSCI U.S. Small-Cap 1750 Index, which is thought to have a slightly clearer construction methodology than the Russell benchmark. However, it should be noted that the MSCI has a higher allocation for mid-cap stocks, and so does the Vanguard fund that tracks it. In fact, the fund currently sports a 41% weighting to mid-cap stocks. But given the run that small caps have enjoyed in recent years, this is not particularly surprising. All in all, the mid-cap allocation should not detract from the fund's overall suitability. If you have a space in your portfolio for a small-cap index, this fund is a good choice.

Overseas opportunities
If you're in the market for a foreign stock index, the Vanguard Total International Stock Index (VGTSX) is a terrific option. This fund is attractive in part because it provides exposure to both developed and emerging markets. Typical index funds that track the MSCI EAFE Index exclude the latter. By investing in three other Vanguard index funds -- the European Stock Index (VEURX), the Pacific Stock Index (VPACX), and the Emerging Markets Stock Index (VEIEX) -- this fund offers a wider array of international investing opportunities. Of course, that emerging-market exposure can cut both ways, and should this area of the market start to cool off, this fund may lag some of its peers. But given its low expenses, broader diversification, and strong track record, the Vanguard Total International Stock Index is truly one of the better international index options available.

Don't forget about bonds
Finally, if a bond index is more your cup of tea, you might want to take a look at the Vanguard Total Bond Market Index (VBMFX). This fund tracks the Lehman Brothers Aggregate Bond Index, probably the most popular broad market bond index around. As such, the fund offers exposure to domestic investment-grade bonds, including Treasury, Agency, and corporate securities. Longer-term performance has been favorable, with the fund ranking above median for its peer group in seven of the last ten calendar years. The fund did suffer a misstep in 2002 when management's policy of substituting short-term corporate bonds for Treasuries backfired, causing the fund to lag its benchmark by a wide margin that year. However, since that time, procedures have been tightened up, and performance has tracked the benchmark very closely.

So while an initial look at Vanguard's index fund menu can be somewhat overwhelming, Foolish investors will likely be best served by sticking to widely diversified, broad market indices such as those listed above. Indexing is not suited to every investor's portfolio or temperament, but if it is, Vanguard is a great place to start looking for some top-notch index funds.

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Whether you're interested in Vanguard index funds or not, if you want to learn more about which mutual funds are winners and which are losers, check out the Fool's Champion Funds newsletter. Fool fund expert Shannon Zimmerman takes an in-depth look at which funds might be right for your portfolio. Start your free 30-day trial today.

Fool contributor Amanda Kish lives in Rochester, N.Y., and does not own shares of any of the companies or funds mentioned herein. Microsoft and Wal-Mart are both Inside Value recommendations. The Fool has a disclosure policy.


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  • Report this Comment On September 20, 2008, at 11:19 PM, tonyleyn wrote:

    I INVEST JUST SHE SAYS 500 AND INTERNATIONAL I HARDLY LOOK AT THE MARKET INVESTMENTS ARE NOT GOOD OR BAD THEY ARE APROPRIATE OR NOT FOR THE INDIVIDUAL

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