The 10 Best Low-Cost Index Funds

Is a low-cost index fund right for you?

Paying higher fees to invest in an actively managed fund erodes your ability to generate compound interest. While index funds are generally broad-based, you can gain additional portfolio exposure to particular market segments by allocating more money to specific stocks or funds in accordance with your investment preferences.

With so many low-cost index funds available, there's little reason to pay more than the bare minimum in fees. Adding a low-cost index fund to your portfolio keeps more of your hard-earned money in your own pocket.

Low-cost index funds are pooled investments with low expense ratios or annual management fees. Investors who focus on minimizing their investing costs can generate vastly superior returns over time since money that would be lost to fees is compounding in your investment account.

Many investors prefer index funds -- which are a type of exchange-traded fund (ETF) -- over mutual funds because of their lower expense ratios and tax-efficient nature.

Index-tracking ETFs typically have low expense ratios because they are passively managed. This keeps operating expenses low.

Passive investing strategies don't require any in-house stock analysis or active trading, so low-cost index funds can allow investors without high levels of risk tolerance to put their money to work in the stock market.

Let's take a deeper dive into a few of these low-cost index funds:

1. Vanguard Total Stock Market Index Fund ETF

If you want to hold a single index fund ETF that invests in the total U.S. stock market and in the right proportions, the Vanguard Total Stock Market Index Fund ETF might be your best option.

Holding shares in this fund means you'll hold large-, mid-, and small-cap companies proportional to the broader market -- and at a bargain-basement 0.03% expense ratio.

For the set-it-and-forget-it investor, this investment strategy is very difficult to match from a time- and cost-efficiency perspective. Many fund management companies offer total market funds at similarly low costs.

2. Vanguard S&P 500 ETF

The Vanguard S&P 500 ETF tracks the S&P 500. The benchmark index is weighted by market capitalization and includes 500 of the largest U.S. companies. The broad diversification of this fund is appealing to many investors.

The S&P 500 is "self-cleansing," meaning that when a particular company no longer qualifies for inclusion in the index, it is replaced by a growing company that deserves to be included. The formulaic nature of the inclusion process ensures that only high-quality companies are listed by the S&P and invested in by S&P 500 index funds, like the Vanguard S&P 500 ETF.

3. Vanguard Mid-Cap ETF

The Vanguard Mid-Cap ETF invests in companies with mid-range market values, with a median market cap of about $36 billion.

The mid-cap market segment includes companies with established businesses and reliable revenue streams, many of which have yet to grow to their full potential.

The ETF tracks the CRSP U.S. Mid-Cap index by aiming to hold the same stocks in the same proportion as the index. The fund's small expense ratio of 0.04% is competitive among mid-cap ETFs.

4. Vanguard Small-Cap ETF

The Vanguard Small-Cap ETF is an attractive option if you want to invest in companies with the most growth potential. The fund tracks the CRSP U.S. Small-Cap index, focusing on U.S. companies in the bottom 2% to 15% by market cap. The median market cap of the roughly 1,370 stocks in the ETF is $8.4 billion.

Investing in a low-cost, small-cap index fund ETF such as the Vanguard Small-Cap ETF can boost your overall returns. However, due to its small-cap focus, this ETF's performance can be more volatile than other investments.

The beauty of an index-based investing style is that you only need to buy and hold -- and be unwaveringly patient. Paying very little for such a strategy is not only possible but also the best way to ensure that you keep the majority of your investment returns over the long haul.

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