Aja McClanahan is a personal finance writer who has a story of getting out of over $120,000 in debt. She's been featured in Yahoo! Finance, MarketWatch, U.S. News and World Report, Kiplinger and has written for publications like Business Insider, Credit Karma, Inc., and many others. Aja writes about investing and personal finance for Wealthsimple. In her spare time, she manages her own investment portfolios for herself, husband, and two kids. Aja double majored in Spanish and Economics and holds a Bachelor of Arts degree from University of Illinois at Urbana-Champaign.
Learning how to invest can seem confusing and complicated, but investing in index funds like the popular Vanguard fund can simplify the whole act of investing.
If you don’t have time to study the markets or financial statements of hundreds of companies to invest in, index funds could be a good option for you. In fact, when it comes to investing for the “average Joe,” experts agree that diversification, minimal expenses, and more passively managed funds might help you get the most out of your investments. And an index fund delivers on all three.
If you’re not sure exactly what Vanguard index funds are or how to invest in them, this guide will help you get started.
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What are Vanguard index funds?
Vanguard index funds are made of companies that are in a stock market index. An index is a collection of securities that can include either bonds or shares of stocks in various companies.
For the purposes of this discussion, we’ll focus mainly on stock-based index funds. However, you should know that Vanguard offers index funds for both U.S. bonds and corporate bonds.
Stock indexes represent a statistically significant portion of the stock market and are often used as a measure for how the market, as a whole, is doing. Many times, more actively managed funds like mutual funds or hedge funds will track their funds against these indexes to gauge their own fund’s performance.
The S&P 500, for example, is an index of 500 of the largest publicly-traded companies. The Dow Jones Industrial Average (DIJA) is another index that tracks 30 “blue chip” or financially mature companies.
If you want to invest in all of the companies that make up these indexes, you’d simply choose the Vanguard fund that corresponds to that index.
Why should I invest in index funds?
Allow us to elaborate.
Picking stocks and funds
The average person usually doesn't have the time to research and successfully execute profitable stock trades. It can be extremely difficult to make good investing decisions if you’re not a professional trader or fund manager. An index fund takes the complication out of investing in stocks and allows you to invest in the stock market without the pain of choosing one or two stocks.
The idea of diversifying your investments is important. Index funds are inherently diversified. Unless you have deep pockets (we’re talking millions here,) or are buying as an institutional investor, putting all your money in individual stocks can be risky. An index fund, on the other hand, allows you to buy stock in several companies at once.
If one company in an index goes belly-up or loses a lot of its value in the index fund you’re holding, you won’t suffer a big loss. Index funds spread your risk across different industries and market segments.
You should be aware of expenses when investing in any type of fund, not just an index fund. Brokerages will charge investors expenses which are expressed as a percentage of the money investing in a fund.
This expense is called an expense ratio and shows how much of a fund is used for operating and administrative costs. Every fund has an expense ratio that you should use to compare different funds for investing. Higher expense ratios can cut into your returns, so it’s ideal to invest in funds with a lower expense ratio.
Because index funds are more passively managed (minimal buying and selling,) the expense ratio tends to be lower. The fund manager simply chooses stocks that reflect indexes like the S&P 500 or the Dow Jones Industrial Average.
According to Vanguard, its fund's average expense ratio is 83% less than the industry average. Because Vanguard is an industry leader when it comes to low-cost investing, its index funds are appropriate for investors who want to spend less and earn more on their investing journey.
How to start investing in Vanguard funds
Once you determine that investing in index funds is right for you, purchasing them is simple.
Research the Vanguard fund you're interested in
Make sure you understand key metrics of the Vanguard index fund you are interested in purchasing. You can go to the Vanguard website and find the information you need to choose the index fund that works for you.
You should look at numbers like:
Average annual returns at the 1-year, 5-year and 10-year mark
Average annual returns since inception
Vanguard’s website is very easy to navigate and has many resources to help you understand your options for index fund investing.
Choosing the fund type: mutual fund vs. ETF
Index funds mainly come in two types: Vanguard mutual funds or Vanguard ETFs (exchange-traded funds.) Mutual funds are more actively managed than ETFs so they will tend to have higher expense ratios.
Another difference between mutual funds and ETFs is the amount of money needed to get started with an investment. For many mutual funds, you might need $1,000 or more to start (but more commonly you’ll need at least $3,000 to get going.)
ETFs, however, allow you to invest in an index fund with smaller amounts of money. Instead of dropping $3,000 on an index mutual fund, you can purchase one share of an ETF based on the very same index for a little as $50.
For example, you can see that Vanguard’s Total Stock Market ETF (VTI) has an expense ratio of just .03% while the Total Stock Market Index Fund Admiral Shares (VTSAX) has an expense ratio of .04% and requires a minimum of $3,000 to invest. Both funds are based on the Dow Jones Industrial Average index but represent a different way to invest.
Choose your broker
Once you choose the index and fund-type to invest in, you’ll need to choose the brokerage through which you’ll make your purchase.
You can either open a Vanguard brokerage account, where you can invest in other non-Vanguard funds and stocks or an account that only holds Vanguard investments. The benefit of purchasing Vanguard index funds with a Vanguard account is that you can buy and sell commission-free.
If, however, you decide to go with another discount brokerage (i.e. TD Ameritrade, E-Trade, etc.), you could be subject to paying a fee on every transaction. Though many brokerages offer commission-free Vanguard ETFs, some may charge $5 or more to buy and sell Vanguard index funds.
Wealthsimple Trade recently launched a brokerage that actually offers tons of commission-free stock and ETF options. So, you have plenty of affordable options when it comes to buying Vanguard index funds.
If you want to minimize the amount of money you’ll be paying to purchase (or even sell) your Vanguard index funds, it might be more cost-effective to do so through a Vanguard account.
Popular Vanguard index funds
Here is a list of Vanguard index funds according to assets under management (AUM.) This list is not an endorsement of any one fund or another but simply a list of the Vanguard funds with the most amount of funds invested:
Vanguard 500 (VFIAX)
Vanguard TSM (VTSAX)
Vanguard Total Stock Market Index Fund; Institutional Plus (VSMPX)
Vanguard Total International Stock Index Fund; Investor (VGTSX)
Vanguard Total Stock Market Index Fund; Investor VTSMX
Investing in index funds (self-directed vs. robo-advisors)
You’re now equipped with all the information and tools you need to create a self-directed investment portfolio. But if all of this seems overwhelming, you might be a good candidate for a robo-advisory service.
Robo-advisors collect information from you like demographics, investing goals, how much you can contribute and how often, and then create an investing plan that makes sense for you. With the help of big data and a whole lot of technology that analyzes investing outcomes for people with similar situations, a robo-advisory service helps you choose the right Vanguard index funds for your financial objectives.
With a robo-advisor, you simply contribute money and the algorithm buys, sells, diversifies, and rebalances your portfolio for you. It can even help make your investments more tax efficient. While you might pay slightly more in expenses compared to self-directed trading you get extra services like advice for this type of service but it could be worth it if your only roadblock is making the moves to get started as an investor. If you do decide to go the robo-advisor route, your best bet is to use a lower-cost provider, like Wealthsimple so that you can save on fees.
Investing in Vanguard index funds are a great way to add diversity to your investment portfolio. With the different methods of investing in Vanguard index funds, you're likely to find one that works for your investing goals, whether you choose the self-directed or robo-advisory route.
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