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Seven of the Best Index Funds

Get 'em while they're cheap.

Russel Kinnel, 10/24/2011

Fund companies are racing to lower index-fund fees thanks to the heated exchange-traded-fund market. Whether you buy ETFs or traditional open-end funds, you are benefiting from this competition. Surprisingly, Fidelity just announced that it is actually raising fees on its Investor share class for Fidelity Spartan International Index FSIIX to 0.20% from 0.10%. Fidelity had long subsidized fees to keep them that low and had given strong indications that it wouldn't raise the fees, so I'm disappointed.

The good news is that Vanguard is rolling out Admiral shares of Vanguard Developed Markets Index VDMIX for 0.12%. With that in mind, let's look at some of the cheapest and best open-end index funds.

Vanguard 500 Index Admiral VFIAX 
For just 0.06% you get exposure to the top of the market. That's quite a bargain for a minimum investment of $10,000. The only knock on it is that total stock market funds have lower turnover and broader exposure. As a result, Vanguard has shifted its emphasis in fund of funds and literature to its total stock market fund. In the past 10 years there has been a huge asset shift between the two. During that time, Vanguard 500 has gained 3.13% annualized and Vanguard Total Stock Market Index VTSAX has gained 4.20% annualized. That difference is exaggerated by the fact that small- and mid-cap stocks have beaten large caps, so I wouldn't expect the difference in the next 10 years to be so great.

Vanguard Total Stock Market Index
This fund charges a basis point more, but 0.07% is still very cheap, helping this fund make sense for a passive investor. The bad part about the ETF boom has been all the crazy niche funds that you don't need. This is the kind of broad core fund that serves investors well.

Fidelity Spartan Extended Market Index FSEMX 
The fees are not going up on this fund, and it a good option to round out your domestic holdings if you already own an S&P 500 fund. The fund owns the next 4,500 largest stocks after the top 500. Thus, you cover mid-caps and small caps nicely.

Vanguard Short-Term Bond IndeVBIRX
With yields on high-quality bonds at pathetically low levels, it makes sense to pinch pennies and buy a fund that charges 0.11%, as this one does. The caveat on bond index funds is that they are nearly all market-weighted, and that means they are dominated by low-yielding government bonds. So this is a decent defensive play, but income is rather meager at just 0.73% for the trailing 30 days.

Vanguard Small Cap Index VSMAX 
Vanguard significantly improved its small-cap indexing when it switched to the MSCI US Small Cap 1750 from the Russell 2000. The Russell's problems were that it rebalanced infrequently and everyone could see the changes coming and bid up the prices of the names going in. Thus, funds tracking the index were stung. Since the switch, the fund has beaten the category average in 85% of rolling three-year periods.

Vanguard Total Bond Market Index VBTLX 
This fund charges just 0.11%, and that's a good thing given how low the bond markets' yields are. Low costs and a hefty government-bond weighting have helped of late. So if you have rather modest expectations, this fund should do the job for you.

Russel Kinnel is Morningstar's director of mutual fund research. He is also the editor of Morningstar FundInvestor, a monthly newsletter dedicated to helping investors pick great mutual funds, build winning portfolios, and monitor their funds for greater gains. (Click here for a free issue). Mr. Kinnel would like to hear from readers, but no financial-planning questions, please. Follow Russel on Twitter: @russkinnel.

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