The Vanguard Emerging Markets Fund: High Risk With Huge Potential

This article was updated on December 15, 2017, and originally published on September 7, 2016.

The Vanguard Emerging Markets Stock Index Fund (VEIEX 0.85%) is a mutual fund designed to give investors low-cost exposure to emerging markets such as China, Brazil, Russia, India, and Taiwan. Also available as an ETF, the fund tracks the FTSE Emerging Markets All Cap China A Inclusion Index Index.

What are emerging markets?

An emerging market is a country that has some of the characteristics of a developed market, and while the exact definition of the term varies, there are some countries that are universally agreed to belong in the category. These include Brazil, Russia, India, and China (known as the "BRIC" countries), as well as markets such as Taiwan, South Africa, and Brazil, just to name a few.

Image Source: Getty Images.

Emerging markets can be attractive places to invest for a few reasons. For one thing, investing in economies that are growing faster than our own provides the potential for some pretty impressive gains. Just to cite one recent example: from 2003 to 2007, emerging markets had a particularly impressive stretch, averaging a 37% return per year. Plus, emerging markets can add diversity to a portfolio that is otherwise filled with U.S. stocks.

However, emerging markets can be risky. Investments in emerging markets are susceptible to foreign exchange risk, lower liquidity, political risk, and the overall increase in volatility that comes with investing in rapidly growing countries and businesses.

For this reason, while emerging-markets investments can produce some pretty impressive returns when things are going well, it's important to understand that they are inherently riskier than U.S. stocks and should be just one part of a well-diversified portfolio.

What does the fund invest in?

As I mentioned in the introduction, the Vanguard Emerging Markets Stock Index Fund and the Vanguard FTSE Emerging Markets ETF (VWO 0.09%) track an emerging-market stock index.

The fund is made up of more than 4,000 stocks, but it's rather top-heavy. In fact, the top 10 stocks make up 18.1% of the fund's total holdings. As of October 31, 2017, the geographical distribution of the fund's assets was:

Source: Vanguard. Top 10 markets as of October 31, 2017.

Costs, minimums, and other considerations

The mutual fund has a $3,000 minimum initial investment and comes with a 0.32% expense ratio. It is also available in "Admiral shares" with a 0.14% expense ratio, but the minimum investment is $10,000. The ETF also has an expense ratio of 0.14%, and the minimum investment is only the price of one share ($43.60 as of this writing).

At first glance, it may seem like the ETF is the better choice, but keep investment commissions in mind. This is especially true if you plan to add to your investment often, as those brokerage commissions add up pretty fast. However, if you invest directly through a Vanguard brokerage account, you can buy this and all other Vanguard mutual funds and ETFs commission-free. (Note: Now that we're done comparing the mutual fund with the ETF, I'll refer to them collectively as the Vanguard Emerging Markets Fund.)

Historical performance

On first glance, the fund's performance doesn't look too appealing, especially over the past decade:

Source: Vanguard. These returns are for the emerging markets mutual fund. Returns for the ETF are slightly different.

However, keep a couple of things in mind. First, the past few years have been full of global economic uncertainty, and some emerging markets have been hit particularly hard after a period of rapid growth.

Second, keep in mind that these are inherently riskier assets, and while they tend to get hit worse when things go bad, there is also potential for high rewards when things go well. Sure, the past few years have been pretty ugly for emerging markets, but also consider that during the 20-year period from 1988 through 2007, the leading emerging-market index of that time period averaged annualized returns in excess of 17%. This is a total return of more than 1,900% over two decades.

A good way to round out your portfolio

Emerging markets can make for extremely rewarding investments, but they also come with elevated risk. The Vanguard Emerging Markets Fund offers a relatively safe way to get some exposure to this asset class, with low fees and a diverse portfolio of more than 4,000 stocks, but it should be limited to a small portion of your well-diversified portfolio.