The best index funds can help you to build wealth by diversifying your portfolio while also minimizing your fees. In general, index funds are a wise choice because passive fund management tends to produce better results than active management in the long run.
Eight best index funds for 2021
To select an index fund, first decide what stock market index you want to track. From there, you'll want to find the fund whose performance most closely correlates with that index. The fund should also have a low expense ratio, which denotes the annual management fee. Using those criteria, here are our picks for the eight best index funds for 2021.
1. Fidelity ZERO Large Cap Index Fund (FNILX)
Investing in S&P 500 index funds is perhaps the closest thing to a guaranteed way to build wealth over time. Fidelity's ZERO Large Cap Index Fund (NASDAQMUTFUND:FNILX) is very similar to an S&P 500 index fund. It tracks an index of just over 500 U.S. large-cap stocks, but because it's not an official S&P 500 index fund, it avoids paying expensive licensing fees to the S&P's parent company. That helps Fidelity offer the mutual fund with zero investment fees -- that's right, the ZERO Large Cap Index Fund has a 0% expense ratio. There's also no minimum investment, making it a good choice for beginning investors.
The fund, which uses the Fidelity U.S. Large Cap Index as its benchmark, delivered a total return of 20.05% in 2020. By comparison, the S&P 500's total return over the same period was 17.4%.
2. Schwab S&P 500 Index Fund (SWPPX)
If you want an official S&P 500 index fund, Schwab's S&P 500 Index Fund (NASDAQMUTFUND:SWPPX) is about the cheapest you'll find, with an expense ratio of 0.02%. That means you'll annually pay just $0.20 for every $1,000 you invest, plus there's no minimum investment. Because the investment fee is so tiny, your returns are virtually identical to the S&P 500 index. As of February 2021, one-year total returns for both were 18.22%.
3. Vanguard Growth Index Fund ETF (VUG)
If you can afford to take on more risk in the pursuit of higher rewards, the Vanguard Growth ETF (NYSEMKT:VUG) is a solid pick. The fund tracks the CRSP US Large Cap Growth Index, which looks a lot like the S&P 500 Growth Index. It invests in each of 255 U.S. large-cap growth stocks. Not surprisingly, tech stocks are heavily represented, accounting for 47% of its holdings, while energy stocks and utility stocks comprise only 0.3% combined.
The VUG has a minuscule 0.04% expense ratio. As of Dec. 31, 2020, the fund's average annual return over five years before taxes was 20.34%, compared to 15.19% for the Vanguard S&P 500 ETF (NYSEMKT:VOO).
4. SPDR S&P Dividend ETF (SDY)
A top index fund for income 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 113 of the highest-dividend-yielding stocks in the S&P Composite 1500 Index, all of which have increased their dividend payments for at least 25 consecutive years.
This fund's 12-month dividend yield as of March 15, 2021, was 2.52% -- well above the S&P 500's 1.46%. The expense ratio, 0.35%, is a bit higher than those of our first three funds.
The fund's top three holdings are ExxonMobil Corp. (NYSE:XOM), AT&T (NYSE:T), and Chevron Corp. (NYSE:CVX). It's light on tech stocks, which don't tend to pay generous dividends, and includes many real estate investment trusts (REITs). REITs typically pay high dividends because they're required to disburse at least 90% of their taxable incomes.
5. Vanguard Real Estate Index Fund ETF (VNQ)
If you want to invest across the real estate market, then the Vanguard Real Estate ETF (NYSEMKT:VNQ) is a solid low-cost pick, with an expense ratio of 0.12%. It's by far the largest real estate index fund, with $33.7 billion worth of assets. Its benchmark 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 business real estate. As of February 2021, the fund's 12-month dividend yield (dividend paid as percent of share price) was an attractive 3.8%.
6. Vanguard Russell 2000 ETF (VTWO)
Small-cap companies, defined as those with market capitalizations between $300 million and $2 billion, have more growth potential than large-cap companies, but they're also higher-risk investments. The Vanguard Russell 2000 ETF (NASDAQ:VTWO), which tracks the Russell 2000 index, is a good place to start for investors who want to take advantage of that potential upside. The fund invests in 2,081 small-cap and mid-cap companies that have a median market cap of $2.8 billion.
As of Jan. 31, 2021, this index fund's largest concentration was in healthcare companies (20.7%), followed by consumer discretionary goods companies (16.2%), and industrials businesses (14.6%). The fund's expense ratio, at 0.1%, is relatively low. In 2020, the Vanguard Russell 2000 ETF outperformed the S&P 500, with a total return of 20.2%.
7. iShares MSCI China ETF (MCHI)
The iShares MSCI China ETF (NASDAQ:MCHI), which more or less mirrors China's equivalent to the S&P 500, soared past the S&P 500 in 2020 with a total return of 28.89%. Its expense ratio is 0.59%, which, according to ETF.com, is slightly lower than the average of 0.7% for a China ETF. Although adding international exposure to your portfolio is key to diversification, and China's growth potential is immense, there are some major risks to investing in the world's second-largest economy. Chinese accounting standards are lacking, there's the risk of trade disputes, and uncertainties surround the recovery from the pandemic. While Chinese stocks surged in 2020, it's worth noting that they've performed poorly compared to U.S. stocks in the past decade.
8. Schwab Emerging Markets Equity ETF (SCHE)
If you're seeking portfolio exposure to high-growth emerging markets but don't want your risk concentrated in a single economy, then 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, and its expense ratio is only 0.11%. The fund has 1,535 holdings, with the largest concentrations in China, Taiwan, India, Brazil, and South Africa.
Keep in mind that emerging markets have historically underperformed compared to U.S. stocks. In the past decades, the Schwab emerging market funds have had total returns of just under 50% vs. more than 260% for the S&P 500. However, 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.