The Beatles song, “I Am The Walrus” was playing when I first walked into my high school senior English class. My teacher asked us to analyze the lyrics. I figured John Lennon wrote it in a Moroccan teashop under a cloud of hashish. Lyrics like, “Sitting on a cornflake” and “Elementary penguin singing Hari Krishna” seemed to be fueled by acid or ganja.
That may be true. But the DVD, Composing the Beatles Songbook, claims that Lennon wrote it to confuse scholars who were trying to dissect the Beatles’ songs. Investors who are new to index funds may feel the same way.
Yes, index funds are powerful tools. Yes, they beat most actively managed funds. But the industry’s mind-boggling (often ridiculous) selection of index funds could stump almost anyone. Vanguard offers more than two-dozen different index funds. They also offer 53 index-based ETFs that trade on the U.S. market.
Vanguard’s competitor, iShares, offers 318 different ETFs, all based on different indices. These focus on industries such as aerospace and defense, pharmaceuticals, healthcare, consumer goods, home construction, oil and gas. You can buy growth, momentum, value, energy, commodity, minimum volatility or factor-based funds. Other ETFs are married to Polish stocks or French stocks, Malaysian stocks or Turkish stocks. If there were companies on the moon, promoters would sell a lunar ETF.
Instead, let me introduce something that’s far more down to earth. I call them the Fab 5 funds. Each is a Vanguard pioneer. Each has been around for at least 25 years. They make as much sense today as they did years ago.
Vanguard’s [S&P] 500 Index Fund (VFINX) was the first one. It tracks a collection of large U.S. stocks. In 1986, Vanguard introduced its Total Bond Market Index Fund (VBMFX). It contains a variety of government and corporate investment grade bonds. The following year gave birth to the Extended Market Index Fund (VEXMX). It gives investors exposure to small and medium sized U.S. stocks. In 1990, Vanguard offered its first two international stock market indexes: their European stock index (VEURX) and their Pacific stock index (VPACX).
The Fab 5 portfolio isn’t fancy. But it’s diversified across most global sectors. According to Vanguard, if its funds were split evenly and rebalanced once a year, it would have averaged a compounding annual return of 8.14 percent over 25 years. That would have turned $10,000 into $70,739.
Vanguard’s Fab 5 Performances
August 30, 1990 – August 30, 2015
|Fund||Compounding Annual Return|
|Vanguard 500 Index Fund (VFINX)||9.8%|
|Total Bond Market Index Fund (VBMFX)||6.2%|
|Extended Market Index Fund (VEXMX)||11%|
|European stock index (VEURX)||7.8%|
|Pacific stock index (VPACX)||2.9%|
|Compounding Annual Average If Rebalanced Each Year||8.14%|
|Growth of $10,000 over 25 Years||$70,739|
|Source: The Vanguard Group|
Some investors might get hung up on each fund’s performance. The Pacific stock index, for example, was by far the worst performer. Its large exposure to the long-suffering Japanese market hindered its progress. But it might be a mistake to shun this index.
Fortunes often flip. The lagging market, during one decade, could be a superstar the next. Instead of picking funds based on past performance or a forecaster’s punt, it’s better to diversify. That’s why the Fab 5 portfolio makes so much sense.
Since 1990, Vanguard and its competitors have offered more investment products. Many, such as the Target Retirement and Life Strategy Funds roll the Fab 5 contents into a single pipe. They’re fabulous products. But more isn’t always better. Sometimes, too many investment choices limit our wealth. When investing, it helps to keep things simple. Diversify. Keep costs low. Avoid speculation. Despite the new ETFs that are launched each year, the Fab 5 funds are still a ticket to ride.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas