Vanguard Index Funds Strategy

index funds vanguard

Continuing on my investing series, in this post I will show you exactly the strategy on how I will invest in Vanguard Index Funds.

Advantages of Vanguard Index Funds

Investing in index funds might the best, easiest, safest long term investment out there for most people. It’s one of my favorites ways to invest.

This investment strategy requires very little work, no skills needed and gives you some of the best returns. This investment strategy outperforms 99% of individual investors and approximately 95% of hedge funds.

More importantly, you can set up and manage a Vanguard index fund with minimal time. In fact, you can set up a Vanguard account in 30 minutes or less.

Let’s review what an index fund is, how to open an account with Vanguard, and the potential earnings it can yield.

What is a Vanguard Index Fund?

An Index fund is a collection of different stocks grouped together into one bundle. When you put money into this fund, you are essentially allowing the company to use your dollars to buy different shares of different types of stocks. What you get back in return are dividends and market appreciation.

This is a stark contrast to you owning just one share of one particular stock like Apple for example.

The Best Vanguard Index Funds to Buy

Here is an example. Vanguard index funds such as VFIAX cost $271.40 per share. If you buy a share, you are the owner of a fund that invests in all the S&P 500 companies.

You don’t have to limit yourself to just the USA’s market, you can elect to buy a share of an international index fund and essentially owning a small portion of every single international stock out there. As of this writing, the price of a VTIAX fund is only $27.84 per share.

Additionally, you can own a small portion of the entire stock market via the VTSAX total stock index fund for the price of around $73.04.

With regards to your returns, you can expect a return of 8.99% in 1 year, 14.03% in 3 years, 10.17% 5 years, 14.71% in 10 years and a return of 6.82% since VTSAX’s inception date of 11/13/2000.

And it doesn’t stop there because there are index funds for every single market you can think of. For example, what if you wanted to invest in bonds? Well, you can invest in the VBTLX total bond market index fund for the low price of $14.68 per share.

Real Estate Investment Trusts

Perhaps you wanted to invest in a real estate index fund. There is the VNQ ETF fund from Vanguard. Each VNQ share cost $87.40, this fund focuses on office buildings and hotels.

Alternatively, you can buy the Vanguard REIT fund VGSLX, currently priced at $124.05 per share.

Your money can potentially earn you a significant return if you invest in these funds mentioned above.

At this point you may be asking this question. Why is this such a good investment?

Let’s review advantages to using Vanguard index funds.

Advantage #1-Low Cost

The biggest advantage of index funds is that they have a low-cost ratio. Vanguard index funds are able to charge you a low fee because these indexes are very simple to assemble and easy to manage due to low overhead. All of these savings Vanguard is passing on to you as the investor.

These funds are what’s known as a passively managed funds.

A passively managed fund is a fund whose investment securities are not chosen by a portfolio manager but instead are automatically selected to match an index or part of the market. This is the opposite of an actively managed fund. An S&P 500 index fund is a passively managed fund that mimics the S&P 500 index.

Morningstar

What you’re buying into is an entire portfolio of stocks that automatically gets balanced and adjusted over time without requiring a lot of work and pay a fee ranging from 0.03% to 0.04% annually.

Are Mutual Funds Better?

In contrast to index funds, managed mutual funds are the exact opposite. A mutual fund is usually managed by professional stock pickers who buy and sell over time to try to beat the market average.

Unfortunately, the increased overhead expenses associated with all of these activities will lead to higher fees, including fees associated with buying and selling frequently.

The average expense ratio for actively managed mutual funds is between 0.5% and 1.0% and may go up as high as 2.5%. If you crunch the numbers these are 12.5 to 62.5 times more expensive than index funds.

Advantage #2-Higher Returns

According to a research. only approximately 8% of actively managed funds managed to beat the market in a span of 15 years.

In order words, for most investors, they will have a good chance of making more money investing in an index fund than they would be investing in individual stocks or mutual funds.

What About Managed Mutual Funds?

If a highly trained professional cannot on average beat the market, an individual stock investor will get the same results. According to this article, a research study showed that only 1% of individual investors actually beat the market.

Mutual funds are just like other investments, there are no guarantee of actually beating the market in the first place.

Individual investors tend to trade emotionally, they panic when the market drop or they try to time the market. All in all, trying to pick winners, timing and fees will hurt an individual’s chances of a profit.

In fact, Warren Buffett, a well-respected investor stated in an interview that 99% of investors will fail when attempting to pick the right time to buy and sell stocks.

What he recommended instead for most investors is to invest in index funds.

Advantage #3-Diversification

One of the main advantages of an index fund is diversification. If you have a stock that is failing, you have the other 499 stocks to cover the loss.

Once again, comparing to active investment in stocks, index funds don’t require you to keep up with the market, picking the hottest stocks or trends and worrying about when to sell your shares.

Advantage #4-Ease of use/less stress

As a previous user of Vanguard, I can attest that Vanguard has a very friendly user interface. It only takes 15 to 30 minutes to open an account. An added bonus is that since Vanguard is so popular, there are many guides, step by step instructions and how-tos specifically for Vanguard users.

I don’t have any experience as an active individual stock investor but I can imagine the stress factor. You basically have to read the Wall Street Journal all day long, follow the market news cycle and other news related to the company you have holdings with. Examples of which include acquisition, quarterly earnings, and executive scandals, the list can go on and on.

Opening a Vanguard Account

Step 1.

Go to Vanguard.com and choose the personal investors option. You will have the option to ask the website to save your preference as a personal investor.

Vanguard Index Fund

Step 2.

Click on “open an account” option on top of the page.

Vanguard Index Fund

Step 3.

Select “Let’s open an account” option.

Vanguard Index Fund

Step 4.

Select the option that fit your needs. I chose the first option since this is most applicable to my situation.

Vanguard Index Fund

Step 5.

Select “no” here if this is your first time setting up an account with Vanguard.

Step 6.

This is the last step and the screenshot is self-explanatory. I am not going through the application process because I am not ready to invest with Vanguard yet.

Vanguard

The whole process including filling out the online application should only take 20 to 30 minutes to complete.

Summary of Vanguard index funds advantages

  1. They have very low fees
  2. Higher long term returns compared to individual stocks or mutual funds
  3. Diversification
  4. Ease of use/less stress compared to active investments

Now that we made a convincing case that index funds is the way to go for the average investor. What is the best way to go about it?

The investing strategy that makes the most sense to me is called a three fund portfolio.

Three Fund Portfolio with Vanguard Index Funds

This strategy consists of three funds. hence the name.

  1. US stock index fund
  2. International index fund
  3. Bond index fund

This strategy gives you the broadest diversification along with the cheapest cost and the highest returns overall.

You have three uncorrelated markets to put your money into. That way if something happens to one of the three markets, you have two others to balance out your portfolio.

3 Fund Portfolio Featuring Vanguard

This post may contain affiliate links, please read our affiliate policy for more details.

Investing can be complicated and overwhelming at times. These three funds below are all you need to successfully execute the 3 fund portfolio strategy.

  1. Stock Market Index Fund (VTSAX)
  2. International Stock Index Fund (VTIAX)
  3. Bond Market Index Fund (VBTLX)

How long do you have until retirement?

In terms of how much and which to buy totally depends on your retirement plan and how close you are to retirement.

The general rule of thumb is that the further you are from retirement the more aggressive you can be with your portfolio.

On the other hand, the more closer you are with your retirement, the more bonds you should have.

If you’re in your 20’s or 30’s, you will be fine with 70% to 90% in stocks and 10% to 30% in bonds.

So your plan is to buy and hold these shares for at least 30 to 40 years. The long term investment can protect you from the short term market downturn and allow you the chance to regain the losses over time.

If you’re a few years from retirement, it makes sense to increase your bonds holdings to 80 to 85% and 15 to 20% in stocks. This will allow for a safer, more stable return in retirement when you need the money.

My Personal Index Fund Plan

For me personally, I am going to put 70% in US Stock Index, 20% in International Stocks and 10% in Bonds. My plan is to regularly contribute money to this fund and adjust the allocations once or twice yearly.

A study buy Charles Schwab, found that investing in the market for at least 20 years will typically deliver solid returns.

I have a preference for Vanguard Index Funds, but it is not the only option available out there.

Vanguard Index Funds Alternatives

Here are two of the cheapest mutual funds tracking the S&P 500:

Schwab S&P 500 Index (SWPPX): The expense ratio is 0.02%, or $2 for every $10,000 invested. There is no minimum initial investment.
Fidelity 500 Index (FXAIX): The expense ratio is also 0.02%. There is no minimum initial investment.

The Balance

Final Thoughts

Let’s quickly point out that I am not an affiliate for Vanguard and I don’t receive any financial incentive whether you use them or not. I used Vanguard for my 401 (k) from my previous employer and liked what they have to offer.

Whether you agree with Index Funds, there are certain advantages to investing in them. They offer diversification and stability over the long term with minimal cost.

The three fund portfolio sounds great but I will probably diversify my investment portfolio further. I plan on trying out Vanguard’s REIT fund and dabble into real estate crowdfunding. I’m planning to update you with my returns in a future post.

What is your investment strategy and what do you think of the three fund portfolio as a investment strategy? Leave a comment below.

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