6 Best U.S. Stock Index Funds in 3 Categories: Morningstar

In a new blog post, Morningstar's vice president for research, John Rekenthaler, examines the most common versions of U.S. stock index funds and selects the six best ones in the S&P 500, total market and small company categories. Rekenthaler notes that these three groups contain more assets than all the other funds in the 1,437-strong field combined.

S&P 500 Funds

This species of index fund is the most homogeneous; they all own the same issues, he writes. Such funds, almost pure commodities, are distinguished by their costs and also by their tracking errors, which represent the amount by which their returns diverge from that of the index. Rekenthaler notes that while tracking error is theoretically important — the point of buying an index fund is to match the benchmark's performance — in practice the leading S&P 500 funds easily achieve that goal. "Smaller funds sometimes miss the mark," he writes, "but not those sponsored by the major providers." The six best funds on his list are all retail S&P 500 vehicles with a five-year track record and an annual expense ratio of less than 0.05%. Each fund's annual tracking error was less than 2 basis points.

Total Market Funds

Rekenthaler had to rake through the weeds for his analysis of total market funds. That's because they use various indexes, so selecting the best option would involve selecting the best benchmark, which cannot be done, he says. "First, perhaps 10 people on the planet can correctly explain the distinctions between the various total market U.S. stock indexes," he notes. "Second, while determining the past's winner is easy, none of those 10 experts (or anybody else) can foretell which benchmark will triumph in the future." On a brighter note, all the best funds on his list are reliably inexpensive. According to Rekenthaler, investment-management companies often launch S&P 500 funds to fill a gap in their product lineups, but only those that are serious about indexing provide total market funds. As a result, their prices are consistently attractive.

Small Company Funds

Rekenthaler writes that he could provide less insight for this fund cohort because small company index funds use a bewildering number of benchmarks. For example, the 75 index funds within the small-blend Morningstar category employ 45 yardsticks. "Forget about 10 people understanding such distinctions!" he says. "The correct number is zero. Forget also about assessing those funds' tracking errors." That said, he notes that as the characteristics of small company indexes vary substantially, it makes sense to consider performance, limiting a search to low-cost funds that employ a previously successful benchmark. Rekenthaler's list of the six best small company U.S. index funds available to the public have annual expense ratios of less than 0.1% and have recorded Sharpe ratios over the past five years that are above the small company index fund average of 0.45 — with Sharpe ratios, higher scores are better. See the accompanying gallery for the best S&P 500, total market and small company funds. Year-to-date performance is as of March 19. Slides: Credit: Chris Nicholls/ALM