Low-cost index funds are pooled investments with low expense ratios, or annual management fees. Investors who focus on minimizing their investing costs can generate vastly superior returns over time since money lost to fees is no longer compounding in your investment account.
Many investors prefer index funds -- which are a type of exchange-traded fund (ETF) -- over mutual funds because of their lower expense ratios and tax-efficient nature. Index-tracking ETFs typically have low expense ratios because they are passively managed, which keeps operating expenses low. Passive investing strategies don't require any in-house stock analysis or active trading.
Choosing a low-cost index fund
Low-cost index funds fit into a few different categories. Understanding these different types can help you choose the best low-cost index fund:
- Total U.S. stock market funds: Investing in total U.S. stock market funds, which track indexes that include all publicly traded U.S. companies, is a solid choice for ultra-minimalist investors who want broad-based exposure to the U.S. stock market.
- S&P 500 index funds: Funds that track the S&P 500 offer one of the simplest ways to gain diversified exposure to the largest U.S. companies.
- Index funds by market segment: Investing in ETFs by market segment is another way to structure your low-cost index fund portfolio. Investing in index funds focused on large-cap, mid-cap, or small-cap companies can help you tailor your portfolio in accordance with your risk appetite.
You can also choose to invest in several of these types of low-cost index funds to maximize your portfolio's diversification.
Best low-cost index funds
These index funds have some of the lowest expense ratios:
|Index Fund||Expense Ratio||Assets Under Management|
|Vanguard S&P 500 ETF (NYSEMKT:VOO)||0.03%||$686.2 billion|
|Vanguard Large-Cap ETF (NYSEMKT:VV)||0.04%||$33.5 billion|
|Schwab U.S. Large-Cap ETF (NYSEMKT:SCHX)||0.03%||$27.9 billion|
|Vanguard Mid-Cap ETF (NYSEMKT:VO)||0.04%||$125.6 billion|
|Schwab U.S. Mid-Cap ETF (NYSEMKT:SCHM)||0.04%||$8.5 billion|
|Vanguard Small-Cap ETF (NYSEMKT:VB)||0.05%||$104.2 billion|
|iShares Core S&P Small-Cap ETF (NYSEMKT:IJR)||0.06%||$60.9 billion|
|Schwab U.S. Broad Market (NYSEMKT:SCHB)||0.03%||$19.0 billion|
|iShares Core S&P Total US Stock Market (NYSEMKT:ITOT)||0.03%||$38.3 billion|
|Vanguard Total Stock Market ETF (NYSEMKT:VTI)||0.04%||$1.1 trillion*|
Let's take a deeper dive into several of these low-cost index funds:
Vanguard Total Stock Market Index Fund ETF
If you want to hold a single index fund ETF that invests in the total U.S. stock market in the right proportions, then the Vanguard Total Stock Market Index Fund ETF is your best option. Holding shares in this fund makes owning other stocks or ETFs redundant unless you want to concentrate your portfolio's exposure in a particular segment of the market.
By holding shares in this fund, you'll hold large-, mid-, and small-cap companies proportional to the broader market -- and at a bargain-basement expense ratio.
For the set-it-and-forget-it investor, this strategy is very difficult to match from a time and cost efficiency perspective. Many fund management companies offer total market funds at similarly low costs.
Vanguard S&P 500 ETF
The Vanguard S&P 500 ETF tracks the S&P 500 (SNPINDEX: ^GSPC), the benchmark index weighted by market capitalization that includes 500 of the largest U.S. companies. The broad diversification of this fund is appealing to many investors.
The S&P 500 is "self-cleansing," meaning that when a particular company no longer qualifies for inclusion in the index, it is removed and replaced by a growing company that deserves to be included. The formulaic nature of the inclusion process ensures that only high-quality companies are listed by the S&P and invested in by the Vanguard S&P 500 ETF.
Vanguard Mid-Cap ETF
The Vanguard Mid-Cap ETF invests in companies with mid-range market values, typically between $2 billion and $10 billion. The mid-cap market segment includes companies with established businesses and reliable revenue streams, many of which have yet to grow into their full potential.
The ETF tracks the CRSP U.S. Mid-Cap Index by aiming to hold the same stocks as the index and in the same proportion. The fund's small expense ratio of 0.04% is competitive among mid-cap ETFs.
Vanguard Small-Cap ETF
The Vanguard Small-Cap ETF is an attractive option if you want to invest in companies that have the most growth potential. This fund tracks the CRSP U.S. Small-Cap Index, which focuses on U.S. companies in the bottom 2% to 15% by market cap.
Investing in a low-cost, small-cap index fund ETF such as the Vanguard Small-Cap ETF can boost your overall returns. But, due to its small-cap focus, the performance of this ETF can be more volatile than other investments.
Performance during COVID-19
At the beginning of the pandemic in March 2020, global stock indexes were down anywhere from 30% to 50%, depending on the market segment. Since then, indexes such as the S&P 500 recovered quite nicely before again falling almost 25% in 2022 from the previous year. If you held low-cost index funds since then, there's a good chance you've seen your net worth expand despite recent poor performance.
Critically, if you instead picked individual stocks and bought and sold at the wrong times, you would not have captured such efficient performance. The beauty of an index-based investing style is that you only need to buy, hold, and be unwaveringly patient. Paying very little for such a strategy is not only possible, but it's the best way to ensure that you keep the majority of your investment returns over the long haul.
Related index funds topics
How to Invest Money: Getting Started with Investing
Before you put down your hard-earned cash, consider your investment style.
Is a low-cost index fund right for you?
Paying higher fees to invest in an actively managed fund erodes your ability to generate compound interest. While index funds are generally broad-based, you can gain additional portfolio exposure to particular market segments by allocating more money to specific stocks or funds in accordance with your investment preferences.
With the availability of so many low-cost index funds, there's little reason to pay more than the bare minimum in fees. Adding a low-cost index fund to your portfolio keeps more of your hard-earned money in your own pocket.