This article was updated on August 10, 2017, and originally published on July 23, 2015.
One of the simplest ways to invest, and get close to market-level returns, is with low-cost index funds. Of these kinds of funds, the Vanguard 500 Index Fund, which tracks the S&P 500, is one of the best-known and one of the largest, trailing only the Vanguard Total Stock Market Index Fund in total assets.
In short, lots of people have decided, since they can't beat the market, they might as well be the market. Is that the right move for you? Furthermore, are there funds that follow other indices that offer better long-term potential? In short, there are other index funds -- as well as individual stocks -- that may be better-returning alternatives, but there's still a lot to like about the Vanguard 500 Index Fund.
Let's take a closer look at the fund itself (including the three different share classes), as well as some alternatives.
Returns depend on which shares you own
Vanguard has long been the stalwart in low-cost index investing, since it was first started by Jack Bogle in the 1970s, and the Vanguard 500 Index Fund was the first of its kind. And while it remains one of the lowest-cost funds, it's important to understand that there are actually three share classes within the fund, and depending on which shares you own, your returns will differ slightly:
|Fund||Minimum Balance||Expense Ratio|
|Vanguard 500 Index Fund Admiral Class (NASDAQMUTFUND:VFIAX)||$10,000||0.04%|
|Vanguard 500 Index Fund Investor Class (NASDAQMUTFUND:VFINX)||$3,000||0.14%|
|Vanguard 500 Index Fund ETF (NYSEMKT:VOO)||N/A||0.04%|
Here's a look at how the expense ratio -- which is the annual cost Vanguard charges to run the fund -- and other factors such as daily market volatility for the ETF, have affected returns:
You can see how the difference in the expense ratio has affected total returns, while the ETF shares have also been affected by the more volatile nature of trading on a stock index. Over a longer period of time, this would likely normalize, since the ETF has the same intrinsic value as the other share types.
Which share class is best?
That depends on several factors:
- How much money you have to invest.
- Where you are investing it:
- Through your employer-provided 401(k).
- A personal account with a discount broker.
- Directly with Vanguard.
- How often you'll invest new money.
For example, a fund balance of below $10,000 in either mutual fund share class will cost you a $20 per-year service fee, while there's no such fee for ETF shares (nor is there a brokerage fee if you buy or sell your ETF shares in a Vanguard account). However, if you trade ETF shares in a non-Vanguard brokerage account, you must pay trading fees to your broker as you would with a stock. As for the mutual funds, your broker may not even offer them, limiting your options. The Admiral shares, as an example, are typically only available directly through Vanguard or through a Vanguard-managed relationship with your employer.
If you're planning to invest less than $10,000, that $20 annual fee makes the "effective" expense ratio much higher, so if you're unable able to get above that threshold, then the ETF might be cheaper. But if you're planning to invest new money regularly, trading fees for the ETF could end up costing a lot more than $20 per year.
In short, if you have the $3,000 minimum to invest and plan to add more on a regular basis (such as monthly) then the investor shares are probably the best bet. If you are starting with less money or will buy new shares only once or twice per year, then the ETF would be cheapest, so long as your trading fees don't break $20 per year.
To put it simply, figure out which share class will result in the smallest total cost in fees and expenses based on how much and how often you'll invest, and invest in that class.
Make it part of a diverse portfolio
Even though the Vanguard 500 Index Fund is already diversified with exposure to the largest U.S. public companies, you can improve your chances of the best long-term returns by not putting all of your eggs in this one basket of stocks.
It's worth considering also investing in funds with more exposure to smaller, growth-oriented companies. The iShares Russell 1000 Growth Index ETF (NYSEMKT:IWF), and the Vanguard Growth ETF (NYSEMKT:VUG), (also available in mutual fund classes like the 500 Index Fund) are two great, low-cost. growth-focused index funds:
Over the past 10 years, both of these funds have outperformed the 500 Index Fund. Historically speaking, that shouldn't be a surprise, as exposure to a broad group of higher-growth stocks typically leads to better performance over time, versus investing only in the largest companies.
Furthermore, index funds such as the Vanguard 500 and can be part of a balanced portfolio that includes individual stocks; it doesn't have to be one or the other.