5 Best Index Funds For Investors Under 40 [Vanguard Extended Market ETF, Vanguard REIT Index Fund]

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May 8, 2015 12:41pm NYSE:AOR NYSE:IXUS

fiveDavid Fabian: Investors that are in their prime earning and compounding years have much different needs than those who are seeking income and capital preservation in retirement. You also have one of the single greatest assets on your side – time.

Every additional year of saving and compounding is a precious commodity that is critical to long-term success when growing your wealth.

Usually investors under 40 have very specific goals as well. These can include: saving for a home, investing for retirement, or growing your child’s college education fund. No matter what your objective may be, having an investment plan in place and monitoring your progress will help ensure you are on the right track.

With that in mind, exchange-traded funds make a perfect investment vehicle to grow your money. These low-cost index funds provide transparency, liquidity, tax efficiency, and a high degree of diversification for your portfolio.

However, ETFs are just a tool to use within the context of your investment accounts and the wide array of options make selecting an appropriate fund daunting. Paying attention to costs, security selection, asset allocation, and other characteristics of these funds is an important task.

Fortunately, I have curated a short list of passively managed ETFs with attractive features that investors under 40 should consider.

Vanguard Growth ETF (VUG)

Dedicating a portion of your portfolio to high quality, large-cap growth stocksshould be a key consideration at this stage of the game. VUG has curated 370 stocks such as Apple Inc (AAPL), Google Inc (GOOGL), and Facebook Inc (FB).

As their name implies, these companies are focused on growing their top and bottom lines to support new products and innovation for the future. While technology dominates the makeup of this index, it also includes a healthy dose of consumer discretionary, health care, and financial companies.

Besides the high level of diversification and sector allocation, one of the most attractive features of VUG is its ultra-low expense ratio of just 0.09%. In addition, ETF sports a very healthy asset base of $19 billion along with steady daily trading volume for excellent liquidity.

VUG has shown a penchant for outperformance as well. According to fund company data, VUG has gained 17.30% in average annualized return over the last half decade, while the SPDR S&P 500 ETF (SPY) has notched a 16.01% profit (though 2/28/15).

Vanguard Extended Market ETF (VXF)

Balance is an important consideration when managing expectations for risk and return. With that in mind, you may want to consider supplementing the large-cap exposure of VUG with small and mid-sized stocks as well. One way to do that is to consider a broad-based index such as VXF.

VXF combines both small and mid-cap stocks into a single basket in order to simplify your portfolio management. These more aggressive equities can show greater volatility, but also have been known to dominate returns in strong bull markets.

This ETF includes over 3,200 stocks spread across a variety of sectors and market caps. Well-known names such as Tesla Motors (TSLA), Las Vegas Sands (LVS), and American Airlines Group (AAL) are some of the top holdings in VXF.

This fund has $4.1 billion in total assets and charges an annual expense ratio of just 0.10%.

iShares Core MSCI Total International Stock ETF (IXUS)

Most investors focus a significant portion of their portfolio on domestic stocks because they have a better understanding and bias towards their home country. Nevertheless, a truly diversified portfolio should include exposure to international stocks as a way to enhance your returns and broaden your equity allocation.

IXUS is a one-stop shop for both developed and emerging market stocks overseas. This ETF includes exposure to Europe, Asia, and other global growth areas.   Japan, the United Kingdom, and Canada represent the top three countries within this index.

One of the advantages of a fund like IXUS versus the iShares MSCI EAFE ETF(EFA) is the broader range of underlying countries and individual stocks.   IXUS owns 3,400 securities versus just over 900 for EFA and includes exposure to North and South America.

This ETF has $1.5 billion in total assets and charges a miniscule expense ratio of 0.14%.

Vanguard REIT ETF (VNQ)

Owning traditional stock funds is an important component of an index growth strategy.   However, it is just as important to include unconventional or alternative asset classes as well. This approach increases diversification, enhances portfolio yield, and can increase returns through strategic positioning.

Publicly traded real estate investment trusts provide direct access to the real property market with liquidity and attractive dividend streams. One excellent way to invest in a basket of these REITs is through VNQ.

This ETF invests in over 140 REITs spread across retail, residential, health care, office, and other specialty sectors. Top companies include well-known names such as Simon Property Group (SPG) and Public Storage Inc (PSA).

VNQ has an effective yield of 3.39% and dividends are paid quarterly to shareholders. In addition, this $28 billion fund only charges a 0.10% expense ratio annually.

Low cost, high yield, and favorable diversification are just some of the reasons that make this ETF an important holding to complement your wealth accumulation efforts.

iShares Core Growth Allocation ETF (AOR)

AOR takes a somewhat different tact by selecting an underlying mix of stocks and bonds through other diversified ETFs. This ETF is perfect for investors that may have smaller accounts, where trading fees would eat into profits for multiple positions. It can also be useful for those that are more concerned about risk and want a balanced index at the core of their portfolio.

As the name implies, AOR is focused on growth through a 60% weighting in domestic and international stocks. In addition, it complements that approach with 40% of the portfolio dedicated to high quality fixed-income to smooth out volatility.

This global and sensible approach helps mitigate the risks of an all stock portfolio through a low-cost index. AOR charges an expense ratio of 0.24 percent and can be used as a central holding or as a building block from which to build off of with more strategic positions.

Final Note: Fixed-Income

These ETFs can be used as tools to access a specific segment of the market rather than trying to pick individual stocks or buy high-fee mutual funds. However, they are always susceptible to the whims of price volatility, which is why I recommend pairing them with a stop loss or sell discipline. This will allow you to participate in the upside, while reducing your downside risk.

I think it’s worth noting the lack of attention towards fixed-income was an intentional omission. In my opinion, there are overwhelming risks to a broad-based index bond fund such as the iShares U.S. Aggregate Bond ETF (AGG). These indexes are often tied too closely to Treasury and investment grade bonds that are highly susceptible to interest rate swings.

In addition, they offer low income yields and poor performance versus several actively managed equivalents. The ability to control credit, duration, sector, and security selection is a huge advantage in the fixed-income world because of the wide dispersion in risk dynamics.

Always remember, the most important thing is to have a game plan and implement it decisively in an effort to produce superior investment results.

This article is brought to you courtesy of David Fabian from FMD Capital Management.

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