This article was updated on October 7, 2015.
Mutual funds are a great way for beginning investors to get their money to work in the stock market, as they allow people to invest small amounts but still get the diversification they need. With actively managed funds having lost out to passive index mutual funds once again in 2014 in terms of relative performance, many investors have gravitated toward low-cost index funds. Among fund companies, Vanguard has the strongest reputation as a leader in the indexing world, with nearly 50 different index funds available to those with as little as $3,000 to invest. As useful as that extensive index fund lineup can be, it's also intimidating to some who are just starting out.
With that in mind, we set out to find Vanguard's best index funds. Obviously, which fund is best for you depends on your particular needs, but when it comes to cost, breadth of coverage, and performance, the funds below stand out from the Vanguard crowd.
Getting your share of the U.S. stock market
For U.S. investors, domestic stock exposure typically makes up the bulk of investment portfolios, and Vanguard has two obvious choices in this realm. The Vanguard 500 Index Fund (NASDAQMUTFUND:VFINX) pioneered the index-fund arena and has dutifully mirrored the returns of the S&P 500 (SNPINDEX:^GSPC) for more than 40 years. With the fund's low expense ratio of 0.17%, you'll pay just $1.70 per year for every $1,000 you have invested in the fund, compared to $10 or more per $1,000 for many actively managed funds. The fund has matched the ups and downs of the broader stock market over the years, with a 10-year average annual return of about 6.8% as of late 2015.
The downside is that the Vanguard 500 Index Fund only gives you exposure to large-company stocks. The Vanguard Total Stock Market Index Fund (NASDAQMUTFUND:VTSMX), though, owns those same S&P 500 stocks but adds small and midsized company stocks to the mix. That has added about a quarter percentage point to the fund's average annual gain, which has risen by about 7% per year over the past decade. The fund comes with the same low expense price tag as the 500 Index Fund.
One area in which index funds can be especially helpful is with investing in foreign stocks, as it can be harder to get investing exposure to companies in other countries. Vanguard has several good choices in the international arena that can give you geographical diversity in your portfolio.
For the one-stop shopping experience, Vanguard Total International Stock (NASDAQMUTFUND:VGTSX) owns shares of companies from around the world, ranging from the largest companies in the industrialized regions of Europe and Japan to up-and-coming stocks in emerging-market countries with faster-growing economies. At just 0.22%, this fund's expense ratio is extremely low, as most international funds take on additional expenses to set themselves up to invest around the world. Because of the strength of the U.S. dollar and the weakness of developed-market economies, performance from international stocks hasn't been as strong as U.S. stocks in recent years, with a 10-year average annual gain of just under 3%.
If you want more tailored international exposure, Vanguard also offers regional index funds. You can focus on Europe, the Asia-Pacific region, or emerging markets, with expense ratios in the 0.26% to 0.33% range. Emerging markets win the performance game here with an average annual return over the past decade of about 4%.
Bonds and fixed-income investments
Vanguard doesn't just have stock index funds. Its Total Bond Market Index Fund (NASDAQMUTFUND:VBMFX) offers complete exposure to bonds of all types, including Treasury bonds, corporate bonds, mortgage-backed securities, and even some foreign bonds. Yields have been low due to the poor interest rate environment, but with an expense ratio of just 0.2%, investors keep as much as possible of their meager income.
Vanguard also offers a fund that specializes in real estate investment trusts. REITs have grown popular because they pay high amounts of dividends, and the Vanguard REIT Index Fund (NASDAQMUTFUND:VGSIX) has become popular in part because of its returns of almost 7% per year since late 2005. Expenses come in at just 0.26% per year, and the fund offers REITs of all kinds, including those focusing on retail, residential, healthcare, and commercial-office properties.
Looking to retire
Finally, Vanguard provides a series of target retirement funds, with specific offerings targeted at those retiring anywhere between 2015 and 2060 at five-year intervals. These funds cost between 0.16% and 0.18% per year, and they include a basket of Vanguard index funds that becomes less aggressive as you draw closer to the end of the defined time horizon. The target retirement fund concept avoids the need to update your portfolio on your own, letting the fund itself handle changing risk exposure as you approach the time when you'll need to draw on your money in retirement.
Vanguard isn't the only choice for index funds, but many investors rely on the company as a leader in the index-fund space. These funds are a good place for any beginning investor to learn more about investing in general.