Vanguard might be the go-to source for investing in index funds. It offers a broad base of high-quality, low-cost funds to choose from. Some are the best actively managed funds that money can buy. Most people can build a strong portfolio using only Vanguard funds.
Start With the Right Structure
It can be helpful to review a simple, but effective, structure called the “core and satellite” before beginning to choose the best Vanguard funds. Your portfolio is built around a “core holding” with this strategy. A large-cap stock index mutual fund represents the biggest portion of the portfolio. Other types of funds, called the “satellite holdings,” make up smaller portions. They balance out the risk level. The prime objective of this portfolio design is to reduce risk through diversification. In other words, you’re putting your eggs in different baskets. Your goal is to achieve this while outperforming a standard benchmark for performance, such as the S&P 500 Index.
A Sample Portfolio
We can look at an example that serves as a model, now that we have a smart design for our portfolio of Vanguard funds:
35% Vanguard 500 Index Admiral Shares (VFIAX): Large-cap U.S. stocks15% Vanguard Total International Stock Index Admiral Shares (VTIAX): Foreign stocks10% Vanguard Explorer (VEXPX): Small-cap stocks5% Vanguard Health Care (VGHCX): Health sector35% Vanguard Total Bond Market Index Admiral Shares (VBTLX): Bonds
This blend of Vanguard funds is an example of a moderate portfolio. It would be a good fit for an investor who has a somewhat high risk tolerance and can invest for at least five years. A holder of this blend should be willing to accept periods of modest market volatility in exchange for the chance that returns would outpace inflation by a healthy margin. The asset allocation breakdown is 65% stocks and 35% bonds.
The Lazy Option
This model includes actively managed Vanguard funds as well as index funds. But you might like the idea of investing only in Vanguard’s index funds. They have extremely low expense ratios, and they track their benchmarks. These features reduce the manager risk of actively managed funds. They don’t require your active attention to make sure everything is correctly allocated. Some investors call a portfolio of index funds a “lazy portfolio” because of the passive nature of index funds. An example of a lazy portfolio of Vanguard funds might include 40% Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX), 30% Vanguard Total International Stock Index Fund Admiral Shares (VTIAX), and 30% Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX). This moderate allocation is made up of 70% stocks and 30% bonds. You don’t have to pay extra fees for someone to actively watch each fund’s mix to ensure that it’s performing the way you want. You can be secure in knowing that the index funds will follow the market index on which they’re modeled.
The Bottom Line
Be sure you’re using a diverse mix of mutual fund categories, no matter which Vanguard funds you choose. You want each to perform well under different market conditions. Index funds that are available only as Admiral Shares require a minimum investment of $3,000. You could also invest in exchange traded funds (ETFs) that follow the same investing strategy. Here are the alternatives suggested by Vanguard:
