Index investing has taken the investment world by storm over the past several decades, with the benefits of low costs and easy access giving rise to hundreds of index-dominated exchange-traded funds that bring in trillions of dollars in assets under management. Yet ETFs and other index-tracking investments all owe a debt of gratitude to the Vanguard 500 Index Fund, which helped pioneer the index-investing strategy from its inception in 1976. Even now, the 500 Index Fund is an easy way to track one of the most popular market benchmarks and get diversified exposure to U.S. stocks. Let's look at the Vanguard 500 Index Fund and how it's still getting the job done for investors.
The basics of the Vanguard 500 Index Fund
The Vanguard 500 Index Fund tracks the performance of the S&P 500. To do so, it uses buys all 500 of the stocks in the index in the same proportion as the S&P 500 does. This allows the fund to capture the index's total return, minus the expenses Vanguard incurs in operating the fund as well as buying and selling the securities it holds.
Over time, Vanguard has worked hard to refine its investing process to minimize the drag that expenses exert on returns. Specifically, Vanguard boasts proprietary techniques that guide its trading to handle changes in cash flow as efficiently as possible. As a result, the fund's 10-year average annual return tracks the S&P 500's theoretical average annual return even more closely than its expense ratio would suggest.
The Vanguard 500 Index Fund has multiple share classes. Its Investor Shares are available with a $3,000 minimum, while its lower-cost Admiral Shares have a minimum initial purchase of $10,000. The Vanguard S&P 500 ETF is also technically part of the fund, even though it's an exchange-traded fund. All told, the 500 Index Fund complex has almost $210 billion in assets under management, putting it among Vanguard's largest funds.
Low expenses have benefited Vanguard shareholders over time. Even for the low-minimum Investor Shares, costs amount to about $17 annually for every $10,000 invested in the fund. For the Admiral and ETF shares, expenses are just $5 per $10,000. Combined with Vanguard's superior tracking skills, that has been enough for average annual returns for the lower-cost Admiral Shares to come within a hundredth of a percentage point of the S&P 500's returns over the past decade, at 8.11%.
What the Vanguard 500 Index Fund lacks
Despite its history, the Vanguard 500 Index Fund isn't the perfect solution for every investor. In tracking the S&P 500, it only includes shares of the market's biggest companies, leaving out small and midsized stocks. Historically, those smaller stocks have had higher returns than their large-cap counterparts. As a result, many investors prefer to use a broader-based fund that includes shares of companies of all sizes. In addition, because the S&P 500 is designed to be an index of U.S. companies, it leaves out foreign stocks that can boost returns and provide further diversification for investment portfolios.
Still, as a way to get large-cap stock exposure, the Vanguard 500 Index Fund's age hasn't rendered it obsolete in any way. The fund has fully participated in the bull-market rally since 2009, producing a 16.5% average annual return over the past five years. It has also done a good job of being as tax efficient as possible, generally avoiding the capital-gains distributions that are much more common at actively managed funds.
Index investing is more popular than ever, and there's no shortage of investments to track just about any index you want. Despite all the innovation over the past 40 years, the Vanguard 500 Index Fund still fulfills the simple mission of giving investors exposure to the biggest portion of the U.S. stock market, and it does so cheaply and efficiently. Investors should still see the fund as a viable choice for their portfolios.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.