Index funds can be an inexpensive way to get diversified exposure to just about any segment or niche of the global markets. Whether it's a subset of international stock markets, a particular sector you don't know well enough to pick individual stocks, or an entire asset class, chances are there's an index fund or ETF (exchange-traded fund) that fits your needs.
But that can sometimes be the challenge: There are thousands of funds, and their objectives -- and fees -- can vary widely. That's why we asked our specialists to pick three high-quality funds that look like timely investments right now. Read on to find out why they chose Schwab U.S. Small-Cap ETF (SCHA +0.58%), Vanguard High Yield Dividend ETF (VYM +0.11%), and Vanguard Health Care ETF (VHT 0.52%).
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An inexpensive and easy way to own small caps
John Rosevear (Schwab U.S. Small-Cap ETF): Some investors find small-cap stocks challenging. On the one hand, they can provide outsized growth. On the other, they can be much more volatile than the stocks of larger companies -- and it's not unheard of for a once-promising small growth company to go out of business entirely. Without good insight into the choices, deciding which small-cap stocks to buy can be a high-stress exercise.
For many investors, a small-cap index fund is a good compromise, providing access to that growth potential with some diversification to smooth out the ride. Charles Schwab's U.S. Small-Cap ETF is a fairly new option, but it's a solid one. It tracks the Dow Jones U.S. Small Cap Total Stock Market Index rather than the more commonly used Russell 2000 Index, which gives it a little more exposure to larger (but still small) stocks than funds like the widely owned iShares Russell 2000 ETF (IWM +0.69%). Here's how the portfolios compare:
| Asset class | SCHA | IWM |
|---|---|---|
| Large cap | 0.29% | 0% |
| Mid cap | 21.54% | 8.25% |
| Small cap | 59.81% | 62.23% |
| Micro cap | 18.36% | 29.52% |
Data source: Morningstar.
Why is that important? A bias toward (somewhat) bigger companies is likely to mean (somewhat) lower volatility over time. And it doesn't have to mean a compromise in performance -- in fact, the strength of mid-cap stocks as a group has helped give the fund's performance a boost over the last nine months or so.
With a low turnover ratio of 11% and a net expense ratio of just 0.05%, this ETF is an inexpensive way to add some well-diversified small-cap exposure to your portfolio.
An index for dividend lovers
Chuck Saletta (Vanguard High Yield Dividend ETF): With even 30-year Treasury bonds yielding below 3 percentage points, direct income from investing is hard to come by these days. That's what makes the Vanguard High Yield Dividend ETF (VYM +0.11%) an intriguing potential investment for those looking for cold, hard cash as a reward for the risks they take by investing.
The Vanguard High Yield Dividend ETF attempts to track the FTSE High Dividend Yield index, which includes companies that generally pay higher-than-average dividends. That focus, along with a low 0.08% expense ratio, gives the ETF two key features that income-oriented investors frequently seek.
First, with a yield of around 2.95%, it provides income right in line with where the 30-year Treasury bonds currently yield. Second, since it provides its yield via stock dividends instead of bond coupon interest, there's potential for the High Yield Dividend ETF to provide higher income levels over time. Indeed, its dividend payout has been generally increasing in recent years, though the payment varies every quarter and hasn't been rising in a straight line.
In a period of generally low interest rates, there's risk in any yield-focused investment, including this ETF. If interest rates rise, income-oriented investors may shift to higher-yield bond offerings due to their higher certainty of being paid than stock dividends -- which are never guaranteed. That could cause this ETF's price to decline, along with the share prices of the companies within it.
Still, the opportunity for dividends to increase over time provides some opportunity for a buffer for the Vanguard High Yield Dividend ETF, even in a period of rising rates. Investors looking for income today should understand the risks of rising rates, but understand that they could certainly do worse than this ETF.
10,000 reasons a day to buy this index fund
Cory Renauer (Vanguard Health Care ETF): Each day, roughly 10,000 baby boomers reach retirement age. According to the U.S. Census Bureau, there will be 83.7 million adults over 65 in America by 2050. That's almost twice the number of senior citizens counted in 2012, and on the whole, they're expected to live much longer than past generations.
While healthcare for older adults is expensive, owning the Vanguard Health Care ETF is dirt cheap. The fund boasts an ultra-low 0.10% expense ratio, which Vanguard estimates at 92% less than average among funds with similar holdings.
Those holdings consist of about 351 stocks in the MSCI US Investable Market Health Care 25/50 index. Although the fund is limited to U.S. companies, many of its larger components are international players. With high exposure to global giants such as Johnson & Johnson, Medtronic plc, and Pfizer, a temporary downturn in one geographic region won't necessarily affect the fund's total returns.
You'll be glad to know this fund has handily outpaced the broader S&P 500 over the past three-, five-, and 10-year periods. An unusual amount of healthcare-related political uncertainty has kept it relatively low recently, and now would be a good time to add this quality fund to your long-term portfolio.
