Choosing the Right Vanguard Fund

When it comes to indexing, few fund companies have the market presence of Vanguard. Offering dozens of 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? We 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 to mind first. After a huge drop in assets during the bear market, it now has more than $87 billion in net assets. If you want exposure to the market's large caps, including companies like ExxonMobil (NYSE: XOM  ) , Procter & Gamble (NYSE: PG  ) , and Intel (Nasdaq: INTC  ) , 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 0.16% 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 Human Genome Sciences (Nasdaq: HGSI  ) and Palm (Nasdaq: PALM  ) .

Investors should be aware that this fund doesn't track 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. So does the Vanguard fund that tracks it; mid-cap stocks currently compose 25% of its total holdings, according to Morningstar.

This mid-cap allocation should not detract from the fund's overall suitability. If you have room in your portfolio for a small-cap index, this fund is a good choice.

Opportunities abroad
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. Many international index funds, which generally track the MSCI EAFE Index, typically 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.

Moreover, that emerging-market exposure has paid off lately, because foreign stocks like CNOOC (NYSE: CEO  ) and Petroleo Brasileiro (NYSE: PBR  ) have put up some impressive returns since the March lows. Given its low expenses, broad diversification, and strong track record, the Vanguard Total International Stock Index is 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 newly renamed Barclays Capital 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 among the top quarter of its peer group during the past three, five, and 10 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 indexes such as those listed above. Indexing is not suited to every investor's portfolio or temperament. But if this style works for you, Vanguard is a great place to start seeking top-notch index funds.

Learn more about the best mutual funds available by reading the Fool's Rule Your Retirement newsletter, where you'll get more expert advice from Foolish fund guru Amanda Kish. Start your free 30-day trial today.

This article, written by Amanda Kish, was originally published on May 7, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the stocks mentioned in this article but does own several Vanguard index funds. Intel is a Motley Fool Inside Value recommendation. Petroleo Brasileiro and Procter & Gamble are Motley Fool Income Investor selections. CNOOC is a Motley Fool Global Gains recommendation. Motley Fool Options has recommended buying calls on Intel. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


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