Legendary investor Warren Buffett has said several times that the best way for the average American to invest isn't to buy individual stocks, but to simply invest in low-cost, passive index funds and let the long-term momentum of American business do the work for you. However, there are hundreds of ETFs that are low-cost passive index funds. How can you choose the best ones for your retirement savings?
When it comes to low-cost index funds, my favorite place to start is Vanguard, the company that pioneered the concept of low-cost index investing for the masses and still offers some of the best products in the market today.
To help get you started, here's why the Vanguard S&P 500 ETF (VOO -1.66%), the Vanguard Real Estate ETF (VNQ -1.33%), and the Vanguard Total Bond Market ETF (BND -0.28%) could make fantastic IRA investments, and some information about each one.
A bet on American business
Buffett has specifically referred to S&P 500 index funds as a bet on American business.
If you aren't familiar, the S&P 500 is a stock index that's made up of 500 of the largest U.S. companies. The index is weighted by market capitalization, which simply means the larger companies in the index carry more influence than the smaller ones. Over long periods of time (several decades), the S&P 500 has historically delivered annualized returns in the 9% to 10% range, depending on the exact timeframe you're considering.
For example, over the past 30 years, the S&P 500 has generated a 1,480% total return, which works out to roughly 9.6% on an annualized basis. And this is a time period that includes the dot-com crash, September 11, the financial crisis, and the COVID-19 pandemic. This means a $10,000 investment in the index 30 years ago would be worth $158,000 today, assuming dividends were reinvested along the way.
Vanguard's S&P 500 ETF only has a 0.03% expense ratio, which allows investors to keep virtually all of their returns. This means for every $10,000 you have in the fund, your annual investment expenses are just $3.
Lots of income and growth, and added diversification
I'm a big believer in real estate as an asset class, especially as a way to add diversification to a traditional stock and bond investment portfolio. Not only does real estate have bond-like income potential, it also has total return potential that is equal to or greater than the stock market. Plus, real estate performance isn't closely correlated with the overall stock market, making it a way to diversify.
The best way to invest in real estate through your IRA is through real estate investment trusts, or REITs. These are specialized companies that pool investor money to buy commercial real estate assets like office buildings, apartment complexes, shopping malls, etc.
The Vanguard Real Estate ETF invests in 183 different publicly traded REITs. Just to name a few of the largest, American Tower (NYSE: AMT) owns a portfolio of communications towers around the world, Prologis (NYSE: PLD) owns warehouses and distribution centers, and Equinix (NASDAQ: EQIX) owns data centers that house computing equipment.
The Vanguard Real Estate ETF pays a 4.8% dividend yield and has achieved a 144% total return over the past decade, even after the recent market downturn, making it an excellent choice for investors who want income without sacrificing long-term growth potential.
Because you don't want to put all of your money in stocks
It's generally a smart idea not to have all of your retirement assets in stocks, and this is especially true as you get closer to retirement. As a financial planner, my favorite rule of thumb is to take an investor's age and subtract it from 110 to determine an appropriate stock allocation -- so, a 40-year old investor would have 70% of their assets in stock-based investments and the other 30% in fixed-income.
For most investors, ETFs are a great way to invest in fixed income, or bond investments, and the Vanguard Total Bond Market ETF is a great way to get broad exposure to the bond market in your portfolio. The fund invests in U.S. government bonds as well as high-quality corporate bonds of varying durations and is designed as an all-in-one fixed-income investment. And with a low 0.035% expense ratio, it's one of the most cost-effective bond investment vehicles in the market.
A great base
To be sure, there are many other excellent ETFs out there -- even within the Vanguard universe -- and there's nothing wrong with using other funds in your strategy. However, these three can provide an excellent base to your portfolio with broad-based stock exposure, bonds for stability and income, and real estate for a bit of diversification.