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All Contents © 2018The Kiplinger Washington Editors
By Kyle Woodley, Senior Investing Editor
| November 3, 2017
Vanguard has built a sterling reputation on low-cost index investing. Founder John Bogle is responsible for the world’s first index fund – what’s now known as the Vanguard 500 Index Fund (VFINX). That concept has grown into a massive business of $4.4 trillion in assets under management by Vanguard, much of which is invested in its extensive line of inexpensive Vanguard ETFs.
And “inexpensive” matters, as fees eat away at returns over time. Let’s say you invest $50,000 apiece in two different funds that gain 8% a year like clockwork, but charge different fees (1.0% and 0.5%). After 30 years, the investment in the more expensive fund would be worth about $372,000, versus about $433,000 from the less expensive fund. That’s a $61,000 difference – no small sum.
Vanguard is one of America’s biggest ETF providers, and for good reason. Its exchange-traded funds deliver an ideal combination of performance potential and dirt-cheap fees across so many categories, an investor can build an entire portfolio from its offerings alone. Here are 10 of the best Vanguard ETFs that can help you accomplish just that.
Data as of Nov. 1, 2017. Click on ticker-symbol links in each slide for current share prices and more. Unless otherwise indicated, yields represent the trailing 12-month yield, which is a standard measure for equity funds. All 10 ETFs are also available from Vanguard as mutual funds.
Market value: $78.2 billion
Dividend yield: 1.9%
The Vanguard S&P 500 ETF (VOO, $236.55) should be a core holding in just about every portfolio because of its ability to do one seemingly pedestrian task: track the market. Vanguard’s VOO holds all the components of Standard & Poor’s 500-stock index – blue-chip stocks such as Apple (AAPL), Exxon Mobil (XOM) and Johnson & Johnson (JNJ) – the same way they’re weighted in the index. In other words, as the S&P 500 gains, so shall you.
But shouldn’t your goal to be to beat the market?
Perhaps, but most investors don’t understand how truly difficult that task is. S&P Dow Jones Indices data shows that in 2016, for example, the S&P 500 index outperformed 66% of all U.S. large-cap equity funds. Put another way, only about one-third of all managers in this space were able to top the large-cap benchmark last year. It gets worse. Over 15 years, just 8% of actively managed large-cap funds beat the S&P 500 index.
Matching the market is no consolation prize, either. The index has returned an average of 11.7% annually between 1973 and 2016. Based on the “rule of 72,” that means the S&P 500 has been doubling investors’ money roughly every six years.
That makes the dirt-cheap Vanguard S&P 500 ETF, which charges a mere 0.04% every year for that exposure, a solid foundation for any account.
Market value: $20 billion
Dividend yield: 1.4%
It’s natural to want to chase some outperformance against the market, however. That’s where allocations to more growth-oriented investments, such as small-cap stocks, come in.
Small-cap stocks typically refer to public companies worth between $300 million and $2 billion by market capitalization (stock price multiplied by the number of outstanding shares). They also have enormous growth potential because of their small size. After all, it’s much easier to double $1 million in revenues than it is to double $1 billion. Naturally, that potential comes with risk – smaller companies typically have less access to capital, and their fates might depend on the success of just one or two products – but you can pare that risk by investing in many small caps in one fund.
The Vanguard Small-Cap ETF (VB, $142.95) holds more than 1,400 stocks with an average market cap of $3.9 billion, providing you with plenty of protection from “single-stock risk” – the potential for a large decline in any one stock to have an outsize effect on the performance of the whole fund. In fact, top holdings including medical devices company Teleflex (TFX) and video game publisher Take-Two Interactive (TTWO) each account for a mere 0.3% of the fund’s assets.
That doesn’t mean there’s no risk. Small-cap stocks typically suffer as a group when market participants become more defensive. But VB can help investors enjoy the growth of the broader small-cap world without worrying about a single company’s implosion wrecking their portfolios.
Market value: $16.1 billion
Dividend yield: 1.0%
Technology is becoming increasingly more important not just in our personal lives, but at work, in healthcare and even in government. Data is becoming more valuable than many hard assets, like machinery and property. Semiconductors are powering everything from computers to cars to refrigerators. That has turned the tech sector into a major driver of growth, and there’s little to suggest that theme should change going forward.
As a result, tech ETFs have become a hot commodity, and Vanguard offers one of the cheapest ways to gain access to the space.
The Vanguard Information Technology ETF (VGT, $163.17) is a robust portfolio of about 361 stocks from all over the tech sector. This includes everything from internet businesses to chipmakers to companies that produce computers or the software they run.
Practically speaking, that means access to Apple and its iPhones, as well as search giant Alphabet (GOOGL) and social leader Facebook (FB). But that also includes communications plays like Cisco Systems (CSCO) and even payment processors like Visa (V) and MasterCard (MA).
Market value: $7.1 billion
Dividend yield: 1.3%
The state of health care from a consumer standpoint looks like chaos. Yes, President Donald Trump and the Republicans have not been able to upend the Affordable Care Act via legislation so far in 2017, but not for lack of trying, and a scrapping of important subsidies means even more tumult for Americans.
From an investing standpoint, though, things should only keep getting better.
The Centers for Medicare & Medicaid Services project continued growth in U.S. health care spending through 2025. CMS expects health care spending to expand 5.6% annually on average until then, eventually reaching $5.5 trillion – accounting for almost 20% of America’s gross domestic product.
That bodes well for most of the 360 or so stocks in the Vanguard Health Care ETF (VHT, $151.08) – a dirt-cheap ETF that provides broad exposure to this area of the economy. Like many health care funds, VHT is heavily invested in pharmaceuticals companies such as J&J and Pfizer (PFE). But this fund also has a hefty 25% weight in biotech companies such as Amgen (AMGN) and Celgene (CELG), health care equipment companies like Medtronic (MDT) and even insurers such as UnitedHealth Group (UNH).
Yes, there is some single-stock risk at the top, with JNJ at almost 10% of the fund’s weight, and PFE and UNH at more than 5% each. But the cap-weighted nature of this fund means it’s most heavily invested in the biggest companies – funds that are more financially capable of weathering any market turbulence.
Market value: $34.1 billion
Dividend yield: 4.8%
Vanguard REIT ETF (VNQ, $82.60) is an important fund because it gives you a lot of something that the S&P 500 does not – real estate.
Real estate investment trusts, or REITs, are businesses that own and sometimes operate real estate (or in some cases, real estate “paper” like mortgage-backed securities). REITs typically are not required to pay federal income taxes, but in exchange for that benefit, they must distribute at least 90% of their taxable income as dividends to shareholders. This often results in high dividend yields, which explains a nearly 5% yield on VNQ that is the envy of most other sector funds.
The problem is, the Vanguard S&P 500 ETF and other S&P 500 trackers only have a 3% weighting in REITs. Thus, you need to buy individual stocks or funds like VNQ if you want to be more heavily invested in this dividend-heavy sector.
The Vanguard REIT ETF holds a diverse selection of real estate, covering residential, retail, office and hotels, among other types. That includes holdings such as mall operator Simon Property Group (SPG), data center company Equinix (EQIX) and self-storage REIT Public Storage (PSA).
Market value: $598.3 million
Dividend yield: 3.1%
Many advisers and experts will say that you should have international diversification in your portfolio. That way, should your heavily American holdings struggle, other markets around the world may be able to pick up the slack.
But international funds that bundle stocks from several countries run the risk of middling performance thanks to a few struggling economies countering the better actors. One way to minimize this risk, then, is to invest in a fund that targets high-dividend international stocks, which can provide returns even if global growth isn’t widespread enough to lift the entire ETF.
The Vanguard International High Dividend Yield ETF (VYMI, $65.94) does just that. You get plenty of international diversification in the form of holdings from a few dozen countries – most heavily from United Kingdom stocks such as HSBC Holdings (HSBC) and BP (BP), and Swiss stocks including Nestle (NSRGY) and pharmaceutical outfit Roche Holdings (RHHBY).
You also get a 3% yield, which is on par with many high-yield large-cap U.S. stock funds. Just note that there are additional tax considerations for dividends paid by international stocks, even if they’re held in an ETF.
Market value: $65.2 billion
Dividend yield: 2.3%
While many international funds (like VYMI) are dedicated to large developed markets with slower-growing economies such as the U.K., Switzerland and Japan, emerging markets such as China, India and Brazil boast economies that are expanding at a much more robust pace. Consider that India finished 2016 with 7.6% GDP growth, while countries like Spain and Australia were at the high end of developed-market growth with just 3% growth.
Thus, emerging-markets ETFs such as the Vanguard FTSE Emerging Markets ETF (VWO, $44.74) – the largest such exchange-traded fund – can have an easier time generating growth across the board.
But economic growth doesn’t necessarily guarantee a smooth uphill market climb. Emerging markets have all sorts of potential pitfalls, such as higher political risk, volatility and foreign exchange headwinds. However, investing in a basket of roughly 4,700 stocks across nearly 30 countries helps defray some of that risk.
China looms largest in this Vanguard ETF, at 31% of the fund’s assets. That includes top-10 holdings such as internet giant Tencent (TCEHY) and the “Chinese Amazon,” Alibaba Group (BABA) – both of which have boomed in 2017, fueling VWO’s 25% gains through the end of October. However, VWO also provides a lot of access to Taiwan, India, Brazil and South Africa, as well as smaller exposure to various emerging markets in Southeast Asia, Africa, Latin America, Europe and the Middle East.
Market value: $2 billion
Dividend yield: 1.5%*
Investors also should be diversified across different asset classes, and that includes bonds, which historically don’t provide as much growth but do act as a source of fixed income that you can rely on in retirement. Vanguard’s ETFs cover a broad swath of the bond world; we’ll start with the Vanguard Short-Term Government Bond ETF (VGSH, $79.55).
The VGSH holds a basket of 145 bonds that are almost exclusively U.S. Treasuries – debt issued with the full faith and security of the U.S. government. And given that America has the highest debt grade possible from two ratings firms (Moody’s and Fitch), and the second-highest grade from Standard & Poor’s, investors can feel pretty secure about that investment.
That’s a large factor behind the VGSH’s small yield – because U.S. bonds are so secure and highly sought-after, the country doesn’t have to offer much in yield to get investors to buy. Another factor is the short-term nature of these bonds. VGSH’s holdings have maturities of three years or less, which means there’s less risk of default versus, say, a bond that matures 20 years from now. There’s also shorter exposure to the detrimental effects of a rapid shift in interest rates.
A fund like VGSH is mostly about short-term safety. Short-term Treasuries tend to be more protected against interest-rate hikes than longer-term bonds, for one. They also can be used to generate a small amount of yield for investors that want to pull some money out of the stock market if they believe volatility and declines are in the offing.
Market value: $2.2 billion
Dividend yield: 4.1%*
The Vanguard Long-Term Corporate Bond ETF (VCLT, $94.27) is a somewhat riskier way to approach fixed income, but also a higher-yielding one. But why is its payout so much more substantial?
For one, corporate bonds are debt issued by companies to generate liquidity, which they can then use to fund expansions, buy other companies or just keep more cash on hand for a rainy day. Because most companies aren’t rated nearly as highly as the U.S. government, they typically need to offer better yields on their bonds to find buyers.
Also, Vanguard Long-Term Corporate’s roughly 1,750 holdings are a lot farther away from maturity, on average. VCLT’s bonds have an average of almost 24 years left until maturity versus just two years for VGSH holdings. As you can imagine, there’s much less certainty about the United States’ ability to pay back a bond in two years than, say, AT&T’s (T) ability to do so in 2041.
Still, all of VCLT’s holdings are rated “investment-grade,” meaning the credit ratings agencies still believe there’s a good chance these debts will be repaid. Plus, you’re also protected against single-company defaults by holding such a large bundle of bonds.
However, if you’re concerned about the long-term nature of the bonds, Vanguard also offers intermediate-term (VCIT) and short-term (VCSH) bond ETFs.
* The yield for this ETF represents the SEC yield.
Market value: $998.5 million
The Vanguard Emerging Markets Government Bond ETF (VWOB, $80.63) provides a healthy yield and some international exposure – along with some added risk.
VWOB allows you to invest in the sovereign debt of 70 developing countries, including the likes of China, Mexico and Brazil. It’s a much more geographically diversified basket than the Vanguard International High Dividend Yield, including in how the top countries are weighted. Vanguard lists its China holdings at 15.9% of the fund – about half the country’s heft in VYMI.
It should come as no surprise when investing in developing countries including Kazakhstan, Egypt and the Ukraine that there’s quite a bit more risk. Only 60% of the fund’s holdings are considered investment-grade, with the rest designated as “junk” by the major credit rating agencies. That implies there’s a higher risk of default, though junk typically commands a loftier yield as a result.
However, default risk again is defrayed by the ETF’s more than 1,000 holdings, as well as an average effective maturity (9.9 years) that’s still technically “short-term” in nature. That, as well as a 4%-plus yield, may be just enough to entice aggressive income investors.
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