Whether you're a 20-something who's just starting to invest or approaching your retirement years, investing your IRA in index funds is a sound strategy. You get automatic diversification, low fees, and the potential for huge growth over the long run.
Your best bet is to choose index funds that give you broad exposure to domestic stocks, plus some international exposure if you want extra diversification. Here are three index funds that are perfect for IRA investors of any age.
|ETF||Expense Ratio||Benchmark Index||Number of Holdings||1-Year Return||10-Year Total Return|
|Vanguard 500 Index Fund ETF (NYSEMKT:VOO)||0.03%||S&P 500 Index||512||14.5%||297.1%|
|Schwab U.S. Broad Market ETF (NYSEMKT:SCHB)||0.03%||Dow Jones U.S. Broad Stock Market Index||2,490||15.5%||296.3%|
|Vanguard FTSE All-World ex-U.S. ETF (NYSEMKT:VEU)||0.08%||FTSE All World ex-U.S. Index||3,497||7.2%||17.2%|
1. Vanguard 500 Index Fund ETF
There are no guarantees in the stock market, but investing in a low-cost S&P 500 index fund like the Vanguard 500 Index Fund ETF is about as close as you can get. Over the past 30 years, the S&P 500 index has delivered average annualized returns of just over 8% when you adjust for inflation.
If you had invested in the S&P 500 any time in the past 100 years, you would have made money every time if you kept the money invested for at least 20 years. If you invested $500 a month in the S&P 500 index and earned 8% annual returns, you'd have well over $1.1 million after 35 years.
This fund has an expense ratio of 0.03%, which means that just $0.30 of a $1,000 investment goes toward fees. It's even cheaper to own than the SPDR S&P 500 ETF, the standard-bearer S&P 500 fund, which has a 0.09% expense ratio.
2. Schwab U.S. Broad Market ETF
If you want to go beyond the bigwigs in the S&P 500 index, look to the Schwab U.S. Broad Market ETF. The fund tracks the Dow Jones U.S. Broad Stock Market Index, which means you'll automatically be investing in around 2,500 of the largest publicly traded companies in the U.S. With an expense ratio of just 0.03%, it's just as cheap to own as the Vanguard S&P 500 ETF.
The advantage of choosing a broad market index fund for your IRA over an S&P 500 index fund is that you get small-cap exposure. Small-cap stocks are typically riskier but have more growth potential.
While a broad market index fund gives you a bit more diversification than an S&P 500 index fund, adding SCHB to your IRA won't give you much additional diversification if you already own S&P 500 funds. That's because there's so much overlap in the largest holdings. Like the S&P 500, the Dow Jones U.S. Broad Stock Market Index is cap-weighted, so the smaller stocks have a limited influence on the fund's performance.
The top eight holdings for both this ETF and the Vanguard S&P 500 ETF are identical: Apple, Microsoft, Amazon, Facebook, Alphabet Inc. Class A and Class C shares, Berkshire Hathaway Class B shares, and Johnson & Johnson. For the Schwab fund, these top holdings account for just over 20% of the fund's assets; for Vanguard, they're just over 25%. Because both funds are dominated by the same stocks, you can expect pretty similar returns.
3. Vanguard FTSE All-World ex-US ETF
If you want global exposure, investing in international stocks through the Vanguard FTSE All-World ex-US ETF is a good option. The fund has an expense ratio of 0.08% and tracks the FTSE All-World ex-US Index, a mix of about 3,500 large- and mid-cap non-U.S. stocks.
More than 85% of the companies are based in developed economies, like Japan, Hong Kong, and the United Kingdom. While investing in primarily developed countries doesn't come with the big rewards of emerging markets, it's also far less volatile.
Although the fund has consistently underperformed compared to the S&P 500 over the past 10 years, investing a small part of your IRA in this international stock ETF could be a good hedge if you want to diversify beyond U.S. stocks without too much risk.