The Ultimate Cheapskate's Index Portfolio

Note: This article is part of Morningstar's Investor Starter Kit special report. This article originally appeared Oct. 2, 2013.

Go on, admit it: If you're the kind of investor who goes three blocks out of your way to save a dollar on groceries, or who insists on cutting your own hair over your spouse's loud objections, you've probably asked yourself a time or two whether you're a cheapskate. Well, even if others do ridicule your sense of frugality, in the world of investing you've got nothing to be ashamed of, not to mention plenty of company. After all, no one awards prizes for Highest Fees Paid.

In fact, keeping expenses low is among the biggest levers investors can use to improve future performance. That's because every dollar you save in fees is one more that stays in your pocket, or, to paraphrase a well-known proverb, a basis point saved is a basis point earned.

The most obvious way for mutual fund and exchange-traded fund investors to minimize their investing costs is to seek out those with low expense ratios. In fact, for some, this is the primary driving force in choosing specific investments to meet their goals. This search for the cheapest way to gain exposure to the markets typically leads to index-based funds and ETFs, which, unlike their actively managed counterparts, don't require a platoon of research analysts or a high-priced fund manager to run their portfolios. Passively managed ETFs often sport the lowest expense ratios in the fund universe. However, it can be more expensive to use ETFs once you factor in transaction fees. Therefore, traditional mutual funds can be a better choice for some investors--for example, those using a dollar-cost averaging strategy.

With all this cost-consciousness buzzing through our heads, we thought it was time to present a guide to the ultimate cheapskate portfolio, one that provides all the tools for a well-diversified pool of investments but costs as little as possible. For each fund type mentioned we've listed the cheapest traditional open-end fund and the cheapest ETF available based on the most recent net expense ratio from an annual report (open-end funds) or prospectus (ETFs). Naturally, we considered only no-load funds for our survey--no self-respecting cheapskate would pay a load--and only funds with minimum investments of $5,000 or less. Finally, in order to build a portfolio that anyone can use, only noninstitutional share classes were allowed.

Not surprisingly, the list is dominated by funds from Vanguard and  Charles Schwab (SCHW), which have been engaged in a price war that has driven down the costs of many index-based funds and ETFs. You can read about the recent history of this price war in this article by Morningstar fund analyst Robert Goldsborough. 

Be aware that the war is still raging, so what is cheapest today may not be cheapest a few months from now. For that reason we've excluded funds that have applied waivers to their expense ratios that lower them only temporarily in favor of those with stronger commitments to keeping costs low. Also, be aware that index funds within the same category may track different indexes, or track the same index differently, which can affect performance. So here's a reminder that, as important as low costs may be, you shouldn't buy any investment without understanding how it works.

For the Lazy Cheapskate
For investors who are no more interested in spending time babysitting their holdings than they are spending money on them, owning just a few funds can provide exposure to most of the world's equity and bond markets. For retirement-focused investors, a single target-date fund, such as those available in Vanguard's ultracheap lineup (its investors pay just 15 basis points in annual fees) would make for a fine choice. But for those otherwise looking to exercise more oversight over their holdings, the following also are worthy.

Funds for the Lazy Cheapskate
	Expense Ratio (%)
Total World Stock
Vanguard Total World Stock Index	0.35
Vanguard Total World Stock Index ETF (VT)	0.19
U.S. Bond
Vanguard Total Bond Market Index (VBMFX)	0.20
Schwab U.S. Aggregate Bond ETF (SCHZ)	0.05
International Bond
Vanguard Total International Bond Index (VTIBX)	0.23
Vanguard Total International Bond Index ETF (BNDX)	0.20

For the Slightly Less Lazy Cheapskate
Hands-off investors who nonetheless would like more control over their allocations to U.S. and foreign stocks than the above portfolios provide may use the following for the equity portion.  

Funds for the Slightly Less Lazy Cheapskate
	Expense Ratio (%)
Total U.S. Stock (all-cap)
Schwab Total Stock Market Index (SWTSX)	0.09
Schwab U.S. Broad Market ETF (SCHB)	0.04
Total International Stock (all-cap)
Vanguard Total International Stock Index (VGTSX)	0.22
Vanguard Total International Stock Index ETF (VXUS)	0.16

For Other Cheapskates
Those who want full control over the allocations of their portfolios may wish to choose from the funds and ETFs below, which are broken down by Morningstar category. One note: In the case of U.S.-equity categories, slightly less expensive ETFs are available from Schwab but those were not included because of concerns about overlapping holdings. In those cases we've opted to go with Vanguard ETFs, which largely avoid this problem.

Funds for Other Cheapskates
	Expense Ratio (%)
U.S. Large-Blend
Schwab S&P 500 Index (SWPPX)	0.09
Vanguard S&P 500 ETF (VOO)	0.05
U.S. Mid-Blend
Vanguard Mid-Cap Index (VIMSX)	0.24
Vanguard Mid-Cap ETF (VO)	0.10
U.S. Small-Blend
Vanguard Small-Cap Index (NAESX)	0.24
Vanguard Small-Cap ETF (VB)	0.10
Foreign Large-Blend
Schwab International Index (SWISX)	0.19
Schwab International Equity ETF (SCHF)	0.09
Foreign Small/Mid-Growth
Vanguard FTSE All-World ex-U.S. Sml Cap Idx	0.45
Schwab International Small-Cap Equity ETF (SCHC)	0.20
Diversified Emerging Markets
Fidelity Spartan Emerging Markets Index	0.33
Vanguard Emerging Markets Stock Index (VEIEX)	0.33
Schwab Emerging Markets Equity ETF (SCHE)	0.15
U.S. Short-Term Bond
Vanguard Short-Term Bond Index (VBISX)	0.20
Vanguard Short-Term Bond ETF (BSV)	0.10
U.S. Intermediate-Term Bond
Vanguard Intermediate-Term Bond Index (VBIIX)	0.20
Vanguard Intermediate-Term Bond ETF (BIV)	0.10