Index funds aren't often thought of as top-notch investment opportunities, but the numbers speak for themselves. According to recently released data from The Wall Street Journal, index funds have outperformed actively managed funds 92% of the time over the past 15-year period.
Index funds also give investors a way to diversify across dozens, hundreds, or even thousands of companies, with a single click of the "buy" button.
With this in mind, we asked three of our Foolish investors which index funds they believe you should take a closer look at this July. Rising to the top of the list are the Vanguard S&P Small Cap 600 ETF (VIOO +0.43%), the Vanguard Total Stock Market ETF (VTI +1.18%), and the PRIMECAP Odyssey Stock Fund (POSKX +1.22%).
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Think small to go big in July
Sean Williams (Vanguard S&P Small Cap 600): Index funds might be an afterthought for investors looking for ways to beat the broad-based S&P 500, but if you're on the lookout for a great idea this July, take a closer look at the Vanguard S&P Small Cap 600 ETF.
Why small-cap stocks? Though small-caps are often attributed with instances of above-average volatility and a higher probability of losing money relative to mid-cap and large-cap stocks, they also have outperformed large-cap stocks over the long run. Between 1926 and 2006, small-cap stocks out-returned large-caps by 2.3 percentage points a year. That may not sound like a lot, but over the course of a couple of decades we could be talking about hundreds of thousands of dollars in extra returns from small-cap stocks.
But, as noted, the danger of investing in single small-cap stocks is they can be prone to volatility and higher risk since their business models are, in many cases, unproven. That's where the Vanguard S&P Small Cap 600 ETF comes into play. It currently holds 602 dstocks, giving you the ability to diversify your money across 602 small-cap stocks with a single purchase. It also has among the lowest expense ratios of ETFs in its class at 0.15% per year. This means you get to hang onto more of your cash since turnover in the ETF should be minimal.
Also consider that small-cap stocks usually have sales and profits that are starting from a smaller base, making it easier for them to grow much faster than their larger rivals. For example, it's a lot easier for a small-cap stock to double sales from $100 million to $200 million than it would be for Wal-Mart to double its sales from nearly $500 billion to $1 trillion. This is why small-cap stocks have the ability to outperform their bigger peers.
Since Sept. 2010, the Vanguard S&P Small Cap 600 ETF has outperformed the S&P 500 by 55 percentage points! If you want an index fund that has a genuine shot at trouncing the market indexes over the long run, consider the Vanguard S&P Small Cap 600 ETF.
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Own it all
Demitri Kalogeropoulos (Vanguard Total Stock Market): Why work so hard at trying to beat (or simply match) the market when you can just own the market? Vanguard Total Stock Market ETF gives investors an easy, liquid, and cheap way to gain exposure to the entire U.S. stock market with one purchase. The fund closely tracks major indexes in price performance and delivers the broader market's overall dividend yield, which today is just below 2%.
Since it's a Vanguard index fund, you can be confident that you're getting unusually low fees. This ETF boasts a net expense ratio of 0.04%, compared to 0.23% for peer funds. Turnover is laughably low, at less than 4%.
So with this purchase, an investor can effectively neutralize three of the biggest factors that tend to doom professionally managed funds to long-term underperformance: chasing past hot trends, overactive trading, and high fees.
The Vanguard Total Stock Market ETF replicates the weighting of the broader market, and so it tends to be more exposed to the largest companies. Its biggest holdings skew toward the tech industry right now as well, with Apple, Amazon.com, and Facebook all sitting in the top five.
There's a good level of diversification built into this fund. But if your portfolio is already thick with exposure to these tech titans, remember that a total stock market index fund will also be sensitive to any big moves these companies make.
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Long-term friendly mindset
Daniel Miller (Primecap Odyssey Stock Fund): With a plethora of funds out there to choose from, it can be tricky for investors to pick what fits their individual needs. Primecap Odyssey Stock Fund is great for investors looking for a large growth fund with a focus on value stocks. It's one of six funds managed by the Primecap team, a team well known for its Vanguard Primecap that has one of the industry's best track records over the prior three decades.
The first thing that caught my eye with this Primecap fund was the management team's reputation for holding on to stocks for the long term, waiting for companies with strong businesses, often with short-term depressed valuations, to rebound. That long-term mindset is also the core of Motley Fool investing, and it helps funds keep expenses and turnover low.
For context, three of its top five holdings are JPMorgan Chase & Co., Southwest Airlines Co. and FedEx Corp -- to give you a better idea of what the management team is buying into. It's performed well for investors with an annualized return rate of 8.27% over the past 10 years and an impressive 26% return over the past 12 months. The fund holds nearly $8 billion in assets with expenses of 0.69% and a turnover rate of just 8%, according to Morningstar.com.
If you're considering funds this summer, Primecap Odyssey is open to investors, ranks as one of the best performing funds in its category, and is one of the cheapest, with a long-term mindset to boot. It's definitely worth considering.
