Invest in low-cost Vanguard funds or save even more money by creating your own passive index funds
There’s a huge new trend in investing and it’s about time. For decades, investors paid high fees to put their money to work and without much to show for it.
The trend to passive index investing through exchange traded funds (ETFs) is saving investors thousands of dollars a year and breaking the long myth to stock-picking. Vanguard Funds has been at the front of this trend with index fund fees that are 81% lower than the industry average.
Against an industry charging an average of 0.62% a year on your money, Vanguard Funds average just 0.12% with some much lower.
That means saving $38,719 over 30 years by investing in low-cost index funds.
But is Vanguard the least expensive option available to investors? Can you create your own Vanguard funds to save even more money and enjoy the stress-free strategy of passive indexing?
What are Index Funds?
Mutual funds have helped millions of Americans invest. These groups of stocks managed by a professional take the guesswork out of picking stocks for the individual investor.
The problem with mutual funds…ok, the biggest problem, was that they were expensive. The average mutual fund charges investors 1% a year on the total invested. That means losing nearly $100,000 after 30 years on a $50,000 initial investment.
All funds charge an expense ratio to pay for portfolio management, administration and marketing. This is above the amount you pay each time you buy and sell the shares. It’s charged on an annual basis on the total amount you have invested, so the amount you pay in fees grows as your money grows.
Index funds were created to give investors a low-cost option. These groups of stocks aren’t based on what a portfolio manager thinks could increase in price but off an index, a formal grouping based on rules.
The most popular index is the S&P 500, the 500 largest companies based in the United States.
By basing stock picks on an index that infrequently changes, you cut down immensely on the amount of work that goes on at the fund. You also cut down on buying and selling in the fund.
That means big savings for investors.
Take a look at the difference in ending value for a $50,000 investment over 30 years. Included are fees of 1% (common among mutual funds), 0.62% (the average fund expense ratio), 0.12% (average Vanguard fund fees) and the ending value with no fee.
Investors lose almost $65,000 to fees just on the average expense ratio. Even investing in low-cost Vanguard funds, the investor pays $13,467 in fees over three decades.
Is there a better way to invest that paying Vanguard nearly $14,000 to do it for you?
Passive Investing in Vanguard Index Funds
Before we get to creating your own Vanguard funds to save money, I wanted to show you how to invest with Vanguard. The fund company really is one of the best, low-cost options and it’s a good choice for someone that wants a stress-free approach to investing.
Investing in Vanguard funds is as easy as picking a few funds and just investing regularly.
In fact, some fans of Vanguard invest in just three funds. I have picked four funds that give you strong diversification across stocks, bonds and real estate. Spreading your money across different asset classes like these is the most important investing decision you’ll make.
Vanguard Total Bond Market (BND) invests in the U.S. bond market for high-quality bonds and charges just 0.05% a year. That means you’d pay just $1 on every $2,000 invested. The fund pays a dividend yield of 2.35% and has provided a 4.4% annualized return over the last decade.
Vanguard Total Stock Market ETF (VTI) invests in the entire U.S. stock market and charges just 0.04% a year. That means you’d pay just $1 on every $2,500 invested. The fund pays a dividend yield of 1.9% and has provided a 7.4% annualized return over the last decade.
Vanguard Total International Stock ETF (VXUS) invests in the global stock market minus U.S. stocks and charges just 0.11% a year. That means you’d pay just $1 on every $909 invested. International stocks haven’t done so well and the fund has only returned 3.6% annually since 2011 but has jumped 20% over the last year.
Vanguard REIT (VNQ) is one of my favorite ways to invest in real estate. The fund invests in shares of other real estate investment trusts (REITs) and charges a 0.12% expense ratio. The Vanguard REIT pays a 4.4% dividend yield and has provided a 6.2% return over the last decade, even after the worst real estate collapse in U.S. history.
Buying broad index funds gives you exposure to thousands of stocks but it also leaves you exposed to sector weightings in the index. For example, when investors bid up tech stocks in the late-90s bubble, the sector accounted for 34% of the index. That meant anyone investing in the index was blindly over-investing in tech and got slammed when the bubble burst.
For a little more diversification, consider investing in sector funds to balance out the weights in the indexes.
Creating Your Own Passive Index Fund of Stocks
Creating your own passive index funds can lower your annual fees down to zero. You don’t pay any fees on individual stocks you own and you really don’t need to buy that many to see your portfolio rise and fall along with the general index.
Creating your own Vanguard funds means picking a handful of stocks from each of the ten sectors; financials, utilities, telecom, technology, materials, consumer staples, consumer discretionary, energy, healthcare and industrials.
Buying two stocks in each sector will give you a portfolio of 20 stocks. Put 65% of your money in these 20 stocks and the remainder in a broad index fund. You’ll save money by not paying fees on two-thirds of your investment but still have exposure to the broad market.
Using this strategy for your investment in U.S. stocks, along with the Vanguard fund above, would lower your fees to just $1 for every $7,142 invested!
Buying many more individual investments means your trading costs will be higher so consider only buying stocks twice a year. Deposit money in your account regularly but wait six months to invest it so trading fees don’t pile up.
Most investors will still want to invest in the Vanguard bond fund rather than buy individual bonds. Bond trading fees can be expensive unless you have more than $200,000 to buy a diversified portfolio of notes. Best to stick with the low-cost index fund.
Remember to invest according to your age and goals. This means investing more heavily in stocks when you’re younger but gradually shifting to safer investments in bonds and real estate as you get closer to retirement.
Investing doesn’t have to be a stressful or expensive part of your life. The idea is to make money, not spend it all on fees. Invest in low-cost passive Vanguard funds or create your own index funds with a simple sector strategy.
