If you're an investor who favors the buy-and-hold strategy of letting carefully vetted investments accumulate meaningful returns over time, index-based exchange-traded funds (ETFs) may be the right vehicle for you. Even investment icon Warren Buffett knows it's difficult to beat index funds, which is why he famously mandated that 90% of the money he bequeaths his wife be invested in an S&P 500 fund.

Of course, you don't have to be like Buffett and park all of your cash in an index fund. But as long-term investments go, these vehicles are an attractive and typically low-cost choice for both large and small investors.

What Is an ETF?

Like a mutual fund, an ETF is a pool of money that invests in stocks, commodities, bonds, or a basket of other assets. Unlike mutual funds, ETF shares trade like common stock on an exchange. Meanwhile, index funds are designed to track the performance of benchmarks like the S&P 500 Index.

Key Takeaways

  • ETFs own underlying assets and divide ownership of those assets into shares, which investors may buy and sell through a brokerage firm.
  • An index fund is designed to mirror the performance of a popular index like the S&P 500 Index or the Dow Jones Industrial Average.
  • The Vanguard Total Stock Market ETF and the SPDR 500 Trust are two low-cost index ETFs investors can buy to participate in the performance of the U.S. stock market.
  • Investors seeking exposure to markets outside of North America might consider investing in the iShares Core MSCI EAFE Fund (IEFA).

If you're a long-term investor planning a portfolio and seeking to add index funds to the mix, there are many to choose from. Below are three of the best based on assets under management (AUM), long-term performance, and expense ratio

The Vanguard Total Stock Market ETF (VTI)

  • Issuer: Vanguard
  • Assets under management: $823 billion
  • One-year performance: 9.00%
  • Expense ratio: 0.03%

If you're uncertain which index to follow, or you wish to invest across a variety of sectors and market capitalization, this may be the fund for you. As the name implies, the Total Stock Market ETF covers the entire domestic stock market in the United States, tracking the CRSP U.S. Total Stock Market Index.

VTI is a balanced fund, with a healthy mix of small-cap, midcap, and blue-chip stocks. VTI is a highly efficient fund with a low expense ratio. AUM are also impressive at more than $800 billion.

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The SPDR S&P 500 ETF (SPY)

  • Issuer: State Street Global Advisors
  • Assets under management: $262 billion
  • One-year performance: 10.15%
  • Expense ratio: 0.09%

First to market, this granddaddy of ETFs attracts a lot of attention from tactical traders and buy-and-hold investors alike. The fund tracks the S&P 500 Index, which is a group of equities—mostly large capitalization—that are listed on the U.S. stock exchanges. Technically, SPDR 500 ETF is a unit investment trust (UIT), which means it cannot reinvest cash dividends between distributions. This minor detail may cause the fund's performance to deviate slightly from the index on which it's based. This fund boasts a solid one-year performance of more than 10%.

Top 3 ETFs

Funds were selected based on a combination of performance over time, expense ratios, and AUM. All figures were current as of Sept. 12, 2019.

The iShares Core MSCI EAFE ETF (IEFA)

  • Issuer: iShares
  • Assets under management: $63 billion
  • One-year performance: 0.15%
  • Expense ratio: 0.07%

IEFA delivers exposure to developed-market stocks in Europe, Asia, and the Far East, excluding domestic and Canadian equities. Its benchmark index, the MSCI EAFE, covers some 98% of global equity markets outside of North America. Furthermore, it includes small-cap stocks in proportion to the market—something competing funds typically do not include. Japan and the U.K. take the top two spots in the fund's portfolio.

Containing nearly 3,000 equities, IEFA is a well-diversified fund and has low ownership costs, making it a prime choice for both short-term and long-term investors who seek exposure to markets outside of North America. The fund is newer than the others mentioned in this article, with an inception date of October 18, 2012. Over the past year, the price of the ETF has fluctuated quite a bit, but have not yet made much progress. Nonetheless, it is has returned 2.6% annually over the past five years and 6.5% annually since its inception.