retirement savings increasing

Why the Vanguard VTSAX Is the Only Fund You Need

If I could invest in only one fund for retirement, without question, it would be Vanguard’s Total Stock Market Index Fund (VTSAX). In fact, this is my primary investment outside of my company 401(k).

Many people tend to overthink saving for retirement; they tend to make it more complicated than it needs to be. But you don’t need to do that, especially with a fund like the VTSAX.

Saving for retirement is probably 90 percent behavior and 10 percent knowledge. Once you know what to do, the key is to do it. And do it consistently. In this case, it is to consistently put money in the VTSAX.

The VTSAX should be a core fund, if not the only fund, in your retirement portfolio.  Here’s why.

What is the VTSAX?

The VTSAX is Vanguard’s Total Stock Market Index Fund.  According to the Vanguard website, here is an overview:

Created in 1992, Vanguard Total Stock Market Index Fund, designed to provide investors with exposure to the entire U.S. equity market, including small-, mid-, and large-cap growth and value stocks.  The funds’s key attributes are its low costs, broad diversification, and the potential for tax efficiency.  Investors looking for a low-cost way to gain broad exposure to the U.S. stock market who are willing to accept the volatility that comes with stock market investing may wish to consider this fund as either a core equity holding or your only domestic stock fund.

Expense ratio:  0.04%

The expenses for this fund are dirt cheap.  Since it’s an index fund, it doesn’t require a lot of management, so the cost is almost nothing. Some mutual funds average around 1% for their expenses.

Minimum investment:  $3000

It’s not the cheapest fund to get started, but it’s not the most expensive either.  You can find some funds around $500 to $1000, but those funds may not be as good.  I can tell you that the VTSAX is worth the $3000 investment.

When you save for retirement, you generally have a couple of options outside of your company 401(k).  You can open a Roth IRA or a Traditional IRA, and either option is available in the VTSAX.

Roth IRA or Traditional IRA?

Assuming the VTSAX yields similar returns to the S&P 500 (which it should), you can anticipate a return close to 12 percent over a 30 year period.

You can use an Investment Calculator to figure out how much you might have at retirement; the answer might surprise you.  Simply enter the amount of years you plan to save, the amount you plan to save, and the rate of return you plan to get.  It’s easy to get results in the millions.

For example, $300 a month for 30 years at 12 percent interest is over a million dollars (and that’s not even close to the amount you should be saving for retirement).

Whether you have a Roth, Traditional IRA, or 401(k), you should be able to get mutual funds that will get you that 12 percent return, but you have to invest in funds that will do that. The VTSAX is one of them.

So at 12 percent, your growth will be the same in either IRA option; however, the amount you pay in taxes will not be the same.

A Traditional IRA or company 401(k) grows tax deferred, meaning you pay the taxes later. A Roth, however, grows tax free, which means you don’t pay any taxes later.  This can result in huge savings on taxes, and that’s why a Roth makes more sense.  You are potentially shielding millions of dollars from being taxed at retirement.

Say you invest $500 a month in your VTSAX for 30 years.  At the end of those 30 years, you will have $1.7M (assuming a 12 percent return). This means that you contributed $180k for $1.5M in growth.

If you invested this in a Traditional IRA or 401(k), you avoid paying taxes on $180k, but will have to pay taxes on $1.7M instead.

On a Roth, you pay taxes on $180k (only tens of thousands of dollars) and pay no taxes on $1.7M (saving hundreds of thousands of dollars).  You could literally save hundreds of thousands of dollars in taxes by going with a Roth. If you want to shield millions of dollars from being taxed, go with a Roth.

Why not a Target Retirement fund?

A fund that has become pretty popular these days is the “Target Retirement” fund.  This is something of a “fund of funds.” It’s one fund made up of other funds.

They take your age into account, anticipating what year you might retire.  They start out more aggressive in stocks and become more conservative in bonds as you get closer to retirement.

That sounds like a great idea, but in reality it’s not.

To be frank, “Target Retirement” funds are not going to get you a good return. They might get you a decent return, but it’s not going to beat what is actually happening in the market.  That’s because the bond funds and international stocks funds are not that great.

For example, take Vanguard’s Target Retirement 2050 fund (this is actually what I started my Roth with). It has one really good fund – the VTSAX – and three other funds that aren’t so good. Those three other funds are in domestic bonds, international bonds, and international stocks. Since those funds do not perform as well as the VTSAX (or even the S&P), your overall returns won’t perform as well either.

Take a look at how the Target Retirement 2050 fund matches up to the S&P:

target retirement 2050 vs s&p 500 index

Not bad, but not where it should be either. The S&P is outperforming it.

If you’re hoping for a 12 percent return, you’ll want something that is going to keep up with the S&P, and Target Retirement funds aren’t gonna do that.

What about a company 401(k)?

If your employer offers a 401(k) match, that is something you definitely want to take advantage of; it’s free money! I have one through my employer, too.

They will generally match a certain percentage. For example, my company matches up to 6 percent, so I contribute up to at least 6 percent to get the match. Technically, I have 12 percent of my income going in my company 401(k), which is pretty solid.

Most financial advisers suggest putting 15 percent of your income towards retirement because that’s what the data shows to be enough if invested properly. This is what wealthy people have done to build wealth in their lifetime, so it’s a goal worth striving towards.

If you contribute 6 percent towards a company 401(k), that leaves you with another 9 percent to put elsewhere. And that’s where a fund like the VTSAX comes in (as a Roth, of course).

Most of the time, you’re not gonna have a whole lot of options to choose from within your company 401(k), but that’s okay. Anything is better than nothing.

If you are able to choose different options, then great! Try to find something like the VTSAX, some sort of total stock market fund that will give you good returns.

What makes a good mutual fund?

A good mutual fund is one that performs as good as the overall stock market. The S&P 500 is usually a good index to compare it to.

Historically, the 30 year return of the S&P has been about 12%. A good mutual fund should give you a similar return (if not better). The VTSAX is a fund that will give you the same return as the S&P (overall stock market). If you can get 12% or better on any mutual fund, I would call it good.  Historically, the VTSAX has done that.

Check out the graph below from Vanguard’s website. This is a hypothetical growth of $10,000 over a 10 year period. You can see that the VTSAX and the S&P have almost identical returns.

total stock market index vs s&p 500 index

What does Dave Ramsey recommend?

First let me say that I’m a huge fan of Dave Ramsey; I highly recommend his books Financial Peace and The Total Money Makeover, and I agree with most of his teachings about money.  However, I think his investing strategy is a little more complicated than it needs to be.  His target audience (the average American) will probably be confused by it.

Ramsey recommends that you buy “good growth stock mutual funds.” I’ve heard this a thousand times.  He doesn’t recommend bonds of any kind, and I agree (stocks it is)!

He recommends dividing your contributions evenly across four different kinds of “good growth stock mutual funds” (a bit more complicated).

The four kinds he recommends are growth, growth and income, aggressive growth, and international growth (so once you know what that means, you’re ready to start investing).

Or you can do something a little easier, and that’s what I do.  Why not start with one fund that is good all around?

I think it’s a lot easier (and more practical) for the average American to start with one fund, especially when they cost $3000 or more.  If you bought four different kinds, you’d be looking at $12,000; that’s a lot to get started.

If you want a single fund that will get you diverse exposure to stocks, I would recommend the VTSAX.  This fund will get you investing in growth and value stocks across small, mid, and large-cap companies.  It will also give you a return consistent to the S&P 500, which is what you want (something Ramsey always talks about).  You can start investing with as little as $3000; you can start it as a Roth – a great addition to your company 401(k) – which is also something Ramsey recommends.

What about bonds?

The VTSAX gives you full exposure to the U.S. equity market; however, it doesn’t give you exposure to the bond market.  I think that’s a good thing for a couple reasons.

First, the bond market doesn’t perform as well as the stock market on average.  You will get a higher rate of return investing in stocks, more so than you ever will with bonds.

Second, if you invest your money in bonds, that’s money that is not being invested in stocks, so your overall return is not going to be as good.

What about international?

The VTSAX also gives you no exposure to international stocks, which is also a good thing (in most cases).

The international market doesn’t perform as well as the U.S. market – plain and simple.  Just like with bonds, when you invest your money in the international market, your returns won’t be as good.  It’s difficult to find international growth funds worth having.  There are some out there, they’re just hard to find.  Most of the time, international stock funds lose to the market overall.

However, if you do find an international fund outperforming the S&P, then add it to your portfolio if that’s what you want to do.  I just find that to be untrue in most cases.

What about diversification?

Some people think that if you’re not invested in stocks and bonds, both foreign and domestic, then you’re not really diversified.  But I don’t think that’s true at all.

The VTSAX is broadly diversified.  It has holdings across small, mid, and large-cap companies, both in growth and value stocks.

Sure it doesn’t have holdings in bonds or international stocks, but those markets suck most of the time.  Investing in those will only hurt your return, diversified or not.

Now, it is possible to find an international stock fund worth having (one that is beating the S&P).  If you wanted to invest in something like that, then do it!  That would be a great addition to your portfolio.

That leaves us with one other fund to consider (remember the four types), and that would be some sort of aggressive growth mutual fund.  If you can find one of those that outperforms the S&P, then you could also do that.  It would also be a great addition to your portfolio.

A good international growth fund and a good aggressive growth fund is all you might need to add to the VTSAX (if you wanted more diversification), but you certainly don’t need to.  The VTSAX is already pretty diversified and poised to give your returns like that of the S&P.  Adding these two funds to the VTSAX might allow you to outperform the S&P, which would be awesome.

Bottom line

The number one reason people don’t have money to retire is because they don’t save for retirement. It’s not the rate of return; it’s not whether their portfolio is diversified; it’s not the kind of mutual funds they have; it’s because they don’t save for retirement. That’s why it’s important to pick a fund (hopefully as a Roth), and throw as much money at it as you possibly can. The VTSAX will allow you to do that!  When you do, you will likely have millions when it’s time to retire.