The best index funds can help you build wealth by diversifying your portfolio while minimizing your fees. Investing in an index fund is less risky than investing in individual stocks or bonds because index funds often hold hundreds of securities. Index funds spread your investment risk across the stocks or bonds of many different individual companies.
How to pick an index fund
Index funds hold baskets of investments to track a market index, such as the S&P 500 (SNPINDEX: ^GSPC). Index funds are passively managed, meaning that the fund's holdings are entirely determined by the index the fund tracks. The goal of an index fund is to match the performance of the underlying index. They're a good choice for long-term investors because you can lock in the returns of the overall stock market or a specific segment of it.
The returns generated by an index fund generally never exceed the performance of the index itself, if only because of index fund expense ratios, which are the annual management fees collected by index fund managers. Since index funds are passively managed, they are actually more likely over the long term to outperform funds with active managers.
An index fund can either be a mutual fund or an exchange-traded fund (ETF). Investors buy shares of mutual funds directly from asset management companies; shares in ETFs are purchased and sold through stock exchanges.
Consider these key factors when picking an index fund:
- Target market segment: Some index funds confer portfolio exposure to the entire U.S. stock market by tracking indexes such as the S&P 500, while other index funds track narrower indexes that focus on specific stock market sectors, industries, countries, or company sizes.
- Your investment goals: Some stock market indexes, and, by extension, some index funds, track companies with specific characteristics such as high growth potential, a history of reliable dividend payments, or adherence to environmental, social, and governance (ESG) standards.
- Expense ratio: An index fund's expense ratio, which is the percentage of your investment that is annually paid as a management fee to the index fund's manager, can vary significantly. A good expense ratio for a total stock market index fund is about 0.1% or less, and a small number of index funds have expense ratios of 0%. More specialized index funds tend to have higher expense ratios.
- Minimum required investment: Some mutual funds have minimum investments of $1,000 or more. ETF index funds are accessible for the cost of a single share. Many brokers also offer ETFs as fractional shares, allowing you to invest for as little as $1.
- Benchmark tracking performance: How closely an index fund tracks its underlying index can vary. The performances of the best index funds are very closely correlated with their benchmark indexes.
9 best index funds for 2022
Our picks for the nine best index funds for 2022 can help you accomplish a variety of investment goals. Plus, they have low expense ratios and low minimum investments.
Because 2022 has been a tough year for stocks, many of the funds listed below are down so far this year. But remember: Index investing is about building wealth for the long haul. Don't let short-term volatility deter you from getting started.
1. Fidelity ZERO Large Cap Index Fund
Investing in S&P 500 index funds is perhaps the closest thing to a guaranteed way to build wealth over time. The Fidelity ZERO Large Cap Index Fund (NASDAQMUTFUND:FNILX), which tracks an index of just over 500 U.S. large-cap stocks, performs very similarly to an S&P 500 index fund. But because this fund is not an official S&P 500 index fund, it avoids paying expensive licensing fees to S&P Global (NYSE:SPGI), the index's parent company. The fund tracks the Fidelity U.S. Large Cap Index as its benchmark.
The "ZERO" in the fund's name denotes that the expense ratio for this fund is 0%. There's also no minimum investment amount, making the fund a good choice for beginning investors.
The fund moves in near-lockstep with the S&P 500. Total returns since its inception in September 2018 were 43.4% as of mid-May 2022, just shy of the S&P 500's return of 44.2% during the same period. In early 2022, the fund was down about 18%, slightly more than the S&P 500.
2. Schwab S&P 500 Index Fund
If you want to invest in an official S&P 500 index fund, then the Schwab S&P 500 Index Fund (NASDAQMUTFUND:SWPPX) is about the cheapest you'll find. Its expense ratio is 0.02%, meaning you'd annually pay just $0.20 for every $1,000 you invest. Because this investment fee is so low, your returns are virtually identical to the performance of the S&P 500.
In 2021, the fund's year-to-date total returns of 31.43% were almost identical to the S&P 500's. By May 2022, both the fund and the S&P 500 were down about 16% for the year to date. There's no minimum investment amount, so you can start investing with as little as $1.
3. Vanguard Growth ETF
If you want to assume more investment risk in the pursuit of higher rewards, then the Vanguard Growth ETF (NYSEMKT:VUG) is a solid choice. The fund tracks the CRSP US Large Cap Growth Index, which performs similarly to the S&P 500 Growth Index. This ETF invests in 266 U.S. large-cap growth stocks.
Tech stocks are heavily represented, accounting for 49.7% of the fund's holdings, followed by consumer discretionary stocks (24%) and industrial stocks (10.3%). Energy stocks and utility stocks combined make up only 0.9% of the fund's value.
This ETF has a minuscule 0.04% expense ratio. As of Dec. 31, 2021, the fund's average annual return over five years (before taxes) was 24.78%, easily beating the S&P 500 over that period.
However, as tech stocks continue to nosedive in 2022, the fund was down through May by around 28% -- significantly more than the S&P 500. Still, investing in Vanguard's Growth ETF could present an opportunity to buy the dip.
4. SPDR S&P Dividend ETF
A top index fund for income-oriented investors is the SPDR S&P Dividend ETF (NYSEMKT:SDY). The dividend-weighted fund's benchmark is the S&P High Yield Dividend Aristocrats Index, which tracks 119 of the stocks in the S&P Composite 1500 Index with the highest dividend yields. All of the companies owned by this ETF have increased their dividend payments annually for at least 25 consecutive years.
Dividend-paying stocks tend to be less volatile compared to the overall stock market. So it isn't surprising that the SPDR S&P 500 Dividend ETF was down just over 3% for the year through May, significantly less than the S&P 500.
The fund's 12-month dividend yield as of May 2022, was 2.71% -- well above the S&P 500's 1.46%. The expense ratio is also somewhat higher at 0.35%.
The fund's top five holdings are manufacturing corporation Leggett & Platt Inc. (NYSE:LEG), IBM (NYSE:IBM), global packaging company Amcor PLC (NYSE:AMCR), ExxonMobil (NYSE:XOM), and National Retail Properties (NYSE:NNN), a real estate investment trust (REIT). Several REITs, which typically pay high dividends because they're required to disburse at least 90% of their taxable incomes, are included in the fund. The ETF is underweighted in tech stocks, which don't tend to pay generous dividends.
5. Vanguard Real Estate ETF
If you want to invest across the real estate market, the Vanguard Real Estate ETF (NYSEMKT:VNQ) is a solid, low-cost option. With an expense ratio of 0.12%, it's also by far the largest real estate index fund, with about $86.3% billion of assets under management.
Its benchmark index is the MSCI US Investable Market Real Estate 25/50 Index, which broadly tracks the U.S. real estate market. Although the index includes a few real estate management and development companies, it consists mostly of equity REITs, which own and operate income-producing real estate.
Because it invests primarily in REITs, the ETF is also attractive to dividend investors. The fund's 12-month dividend yield as of May 2022 was 2.45%. The Vanguard ETF may also appeal to investors concerned about inflation since real estate is traditionally seen as an inflation hedge.
6. Vanguard Russell 2000 ETF
The Vanguard Russell 2000 ETF (NASDAQ:VTWO), which tracks the Russell 2000 (RUSSELLINDICES:^RUT), is a good place to start for investors who want to take advantage of the potential upside of investing in small-cap companies. The fund invests in 2,032 small- and mid-cap companies that have a median market capitalization of $2.9 billion.
As of March 31, 2022, the index fund's largest concentration was in healthcare (16.1%), financials (15.9%), and industrials (15.4%). The fund's expense ratio, at 0.1%, is relatively low, especially for one that offers exposure to the companies with the most growth potential.
Like its benchmark index, the Vanguard Russell 2000 ETF underperformed the S&P 500 during the first five months of 2022, declining about 20%.
7. VanEck Semiconductor ETF
Thematic investors who want to capitalize on a long-term secular trend should check out the VanEck Semiconductor ETF (NASDAQ:SMH). The index fund tracks the MVIS U.S. Listed Semiconductor 25 Index, which tracks 25 domestic and international companies that produce semiconductors and related equipment. It has $7.8 billion in total net assets and an expense ratio of 0.35%.
It has been a rocky 2022 for semiconductor stocks amid ongoing chip shortages, a broader tech sell-off, and a shortage of skilled workers. But plenty of trends point to a bright future for the industry. These include the shift to electric vehicles and 5G mobile technology and a continued surge in cloud-based solutions.
With supply chain woes expected to persist for some time, the VanEck Semiconductor ETF is only appropriate for investors with a long time horizon and a relatively high risk tolerance. As of mid-May 2022, the fund was down about 25%. But, with the semiconductor market projected to almost double by 2030, buying this index fund in a bear market could be a smart play for long-term investors.
8. Schwab Emerging Markets Equity ETF
If you're seeking portfolio exposure to high-growth emerging markets but don't want your risk concentrated in a single economy or region, the Schwab Emerging Markets Equity ETF (NYSEMKT:SCHE) may be a good fit. It tracks the FTSE Emerging Index, a collection of large- and mid-cap stocks in more than 20 developing countries. The fund has 1,843 holdings, with the largest concentrations in China, Taiwan, India, Brazil, and South Africa. Its expense ratio is only 0.11%.
The stocks of companies in emerging markets have historically underperformed compared to U.S. stocks. Between 2012 and 2021, the Schwab emerging market funds, on a combined basis, had total returns of about 67%. The S&P 500, meanwhile, racked up total returns of more than 350%. Considering that about 85% of the world's population lives in developing countries, investors with a long-term focus who are comfortable with volatility may want to seriously consider investing in this fund.
9. Fidelity U.S. Sustainability Index Fund
Investors who are interested in sustainable investing should check out the Fidelity U.S. Sustainability Index Fund (NASDAQMUTFUND:FITL.X). The fund's benchmark is the MSCI USA ESG Leaders Index, which tracks the performances of large- and mid-cap domestic stocks with above-average ESG ratings. The index fund has a low expense ratio of 0.11% and no minimum investment amount.
The fund's largest concentrations as of March 31, 2022, are in the technology (28.6%), healthcare (13.5%), and consumer discretionary (12.8%) sectors. This sustainability ETF's top holdings are Microsoft (NASDAQ:MSFT), Tesla (NASDAQ:TSLA), Google parent Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL), Nvidia (NASDAQ:NVDA), and Johnson & Johnson (NYSE:JNJ).
Although ESG funds are appealing to those who want to invest with a conscience, a strong ESG focus is also good for returns. Companies that pose little ESG-related risk often deliver superior financial performance, making ESG funds such as the Fidelity U.S. Sustainability Index Fund a good choice for long-term investors.
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So what kind of returns can you expect if you buy an index fund? Depends on the fund.