Low-cost index funds are those 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 money no longer compounding on itself 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 for you:

  • 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 America's largest 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%

$739.5 billion

Vanguard Large-Cap ETF (NYSEMKT:VV) 

0.04% $36.7 billion

Schwab U.S. Large-Cap ETF (NYSEMKT:SCHX)

0.03%

$30.4 billion

Vanguard Mid-Cap ETF (NYSEMKT:VO)

0.04%

$151.3 billion

Schwab U.S. Mid-Cap ETF (NYSEMKT:SCHM)

0.04%

$9.7 billion

Vanguard Small-Cap ETF (NYSEMKT:VB) 0.05% $135.2 billion
iShares Core S&P Small-Cap ETF (NYSEMKT:IJR) 0.06% $72.4 billion

Schwab U.S. Broad Market (NYSEMKT:SCHB)

0.03%

$21.2 billion

iShares Core S&P Total US Stock Market (NYSEMKT:ITOT)

0.03%

$39.6 billion

Vanguard Total Stock Market ETF (NYSEMKT:VTI)

0.04%

$1.2 trillion*

Data sources: Fund providers, ETFdb.com. *Includes both ETF and mutual fund classes.

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 America's 500 largest 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 does deserve 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.

This 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 15% to bottom 2% by market cap.

Investing in a low-cost, small-cap index fund ETF like 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.

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 specific 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.