We Fools might be stock market junkies, but we recognize that not every investor has the time or inclination to pick their own stocks. That's why we are strong believers that index funds can be a great place for long-term investors to park their savings.
But which index funds, in particular, are a good bet for the long term? We asked a team of investors to weigh in, and they picked the Vanguard Dividend Appreciation (VDADX 1.04%), the Vanguard FTSE Emerging Markets ETF (VWO 1.66%), and the PowerShares Dynamic Software ETF (PSJ 1.56%).
Dividends meet compound interest
Maxx Chatsko (Vanguard Dividend Appreciation): There's a reason Vanguard is far and away the most successful curator of mutual funds on the planet. A few reasons, actually. Ultra-low fees, accessible funds, and simplicity have combined to make Vanguard funds an easy way for individual investors to build wealth for the long haul. That's why you might want to take a closer look at the Vanguard Dividend Appreciation Index Fund.
There are two versions of the fund: Investor Shares and Admiral Shares. The former requires a minimum investment of just $3,000 and boasts an expense ratio of 0.17%, which is 83% lower than comparable funds. The latter requires a heftier starting pledge at $10,000 minimum but offers an expense ratio of just 0.08%, which is lower than 92% of comparable funds.
Both flavors of the Vanguard Dividend Appreciation Index Fund aim to track the NASDAQ US Dividend Achievers Select benchmark, which itself tracks the performance of high-quality companies with a history of increasing their dividends over time. In other words, the Vanguard fund owns shares of roughly the same companies in roughly the same proportions.
It's worked out well for investors. The Vanguard Dividend Appreciation Index Fund Investor Shares has returned a compounded annual rate of return of 8.2% since it was created in 2006, about the same as the benchmark's 8.4% return per year. A minimum investment of $3,000 made at inception would be worth $7,914 today. Not bad for surviving the Great Recession -- and a great lesson in the value of long-term investing and compound interest, especially when dividends are sprinkled on top.
Seeking growth overseas
Sean Williams (Vanguard FTSE Emerging Markets ETF): Though it's been an underperformer in recent years, the emerging-market focused Vanguard FTSE Emerging Markets ETF, which closely tracks the FTSE Emerging Index, looks like a solid long-term bet.
Emerging markets certainly bring more reward potential, and more risk, to the table for investors. This particular Vanguard ETF has its assets spread out across about two-dozen countries, including China (32.7%), Taiwan (14.4%), India (10.9%), Brazil (8.4%), and South Africa (7.9%), which combine for more than 74% of the fund's $95.8 billion in assets under management. Though volatile at times, these are markets that have the potential to grow GDP at a considerably quicker rate than the U.S. or Europe. They may also be a solid investment choice if inflation fears keep rumbling at the surface in the United States.
What's more, foreign stocks in emerging market economies are relatively inexpensive, making the Vanguard FTSE Emerging Markets ETF cheap, too. The average stock in the index has an earnings growth rate of 11.5%, yet a price-to-earnings ratio of just 15.6, and a price-to-book ratio below two. To boot, it has an annual yield of 2.3%, which is higher than the S&P 500.
Now, here's possibly the best part: The annual net expense ratio is just 0.14%, which is considerably lower than similar emerging-market funds. Turnover tends to be pretty low -- only about 6% per year -- which means you're not paying exorbitant fees to have the fund managed.
Don't let its recent underperformance fool you. This emerging market ETF has the growth, geographic diversity, and brand-name components to be successful.
A diversified way to play a tech megatrend
Brian Feroldi (PowerShares Dynamic Software ETF): There's a tectonic shift happening in the tech space right now that you've probably heard of: cloud computing. The idea is to shift large computing tasks to data centers over the internet instead of processing them on a local computer. This allows users to handle complex computing tasks like video processing, word processing, and hundreds of other applications through any internet-connected device. What's more, software updates are performed seamlessly in the data centers where the processing is done, so end users never have to worry about whether they are running the most up-to-date version of the program.
For investors, the biggest advantage of the shift to the cloud is that it turns one-time software sales into a subscription business. This subtle change provides cloud companies with predictable, high-margin revenue, which is something growth investors crave.
So, what's the best way for passive investors to take advantage of this trend? A solid option is the PowerShares Dynamic Software ETF. This index fund holds positions in 30 companies that are either pure-play cloud-computing companies or other software makers that are making the shift.
If you are looking for proof as to whether or not this fund's focus on the cloud is paying off, consider this: The PowerShares Dynamic Software ETF has outperformed the S&P 500 over the last 1, 3, 5, and 10 years. Not by a small margin, either -- this ETF is up a blistering 314% over the last 10 years, which blows past the 94% return of the S&P 500.
Looking forward, I think the continued move to the cloud will help drive market-beating returns for many companies that are driving the change. If you agree, then this ETF will likely continue to be a highly profitable investment for shareholders who can patiently stomach the eventual ups and downs.