Beyond equity index funds: Bonds, international stocks, and real estate

When it comes to selecting funds within their 401(k) or IRA plans, many Americans allocate a bulk of their nest eggs to equities. According to the Employee Benefit Research Institute (EBRI) and Investment Company Institute (ICI) joint study, 71% of 401(k) participants' assets were invested in equity securities at year-end 2022, primarily through equity funds, balanced funds, and company stock. And some owners of all types of investment accounts are increasing their holdings in index funds for good reasons: the potential for broad market exposure, lower operating expenses, and lower portfolio turnover. 

However, most retirement savers are only familiar with large-blend equity index funds. In reality, individual investors have a wealth of available index funds offering investments in small-cap and mid-cap U.S. companies, bonds, international stocks, and real estate. 

Did you know? Companies are categorized by market capitalization, which is their total value calculated by multiplying share price by outstanding shares. Small-cap firms, typically under $2 billion, offer high growth potential but higher risk. Mid-cap companies, valued between $2 billion and $10 billion, aim to balance growth and stability. Large-cap companies, exceeding $10 billion, are established, stable giants often paying dividends.

Read on if you’re looking to learn more about the many options you have when it comes to index funds.

U.S. small- and mid-cap index funds

Index funds investing in small-cap and mid-cap American companies allow you to diversify your investment in companies that have smaller balance sheets than more established companies. By using a U.S. small and mid-cap index fund as part of a well-diversified portfolio, you can increase your exposure to and potential gains in the U.S. market during periods of expansion.

Besides tracking the components of the S&P 500, index funds can also track the components of other benchmarks, such as the CRSP US Small Cap Index (a broadly diversified index of stocks of small U.S. companies) and the CRSP US Mid Cap Index (a broadly diversified index of stocks of mid-size U.S. companies).

Here are some examples of index funds:

*Please note that these are not representative of any actual index fund; these are created and used for illustrative purposes only.

When selecting an index that focuses on small or mid-cap companies, be sure to double-check its investment strategy. While a standard index fund focuses on providing exposure to a broad range of companies, a growth index fund focuses on growth-oriented companies that are expected to grow revenue and earnings more quickly than their peers. On the other hand, a value index fund focuses on companies that may be considered undervalued.

International stock index funds

If you have a higher tolerance to risk or are many years away from retirement, you could leverage an international stock index fund to gain equity exposure to foreign economies at a low cost. An advantage of using an international index fund over independently buying the shares of an international company is that you’re less likely to face liquidity issues.

Keep in mind that international index funds can focus on different types of economies. Most investment firms focus on developed markets (e.g., Germany and the UK), emerging markets (less developed markets, including Brazil, Russia, India, and China), and frontier markets (markets experienced accelerated growth that may become emerging markets, such as Jordan, Nigeria, and Sri Lanka). Most investment firms follow the MSCI market classification, but often decide to include or exclude nations depending on the fund’s investment strategy.

Additionally, some index funds may focus on a single foreign stock market or track small-, mid-, or large-cap equities across several markets.

Bond index funds

Besides being useful to diversify your portfolio, a bond index fund can help you to gradually switch your portfolio from a growth strategy to an income strategy as you get closer to your retirement age. If you’re holding a target-date fund, it’s doing just that. Instead of paying the often higher fees of a target-date fund and settling for a one-size-fits-all investment approach that may not be suitable for your unique situation, you could increase your allocation to fixed-income securities on your own with a bond index fund. 

To help you decide whether or not target-date funds should be part of your portfolio, review: Target date funds in 401(k) plans: Good or bad idea?

Some bond index funds can provide you with exposure to intermediate-term and long-term domestic bonds at a low cost. Other bond index funds provide you with exposure to the domestic bond market as a whole through holdings in U.S. government and corporate bonds of most maturities.

Just like with stocks, bond index funds can also provide exposure to international markets. While international bond index funds may use currency-hedging strategies against uncertainty in future exchange rates, keep an eye on the credit quality of bonds included in the portfolio.

Real estate index funds

While many individual investors may not be able to afford to buy one property or stake in a real estate investment trust at a time, all individual investors could leverage a real estate index fund to gain exposure to the real estate market.

On the previous list of bond index funds, you may have spotted one that aims to generate returns closely correlated with inflation. However, another way to potentially hedge against inflation is exposure to real estate.

Depending on your tolerance to risk, time left until retirement, and your level of concern about the future of inflation, financial advisers would recommend you to allocate from 5% to 20% of your portfolio to a real estate index fund. Allocating less than 5% may not work as a shield against inflation, and allocating beyond 20% leaves you exposed to the high volatility of some real estate markets.

The bottom line

If your plan doesn’t offer you access to index funds or just limits you to very few options, consider Human Interest, which includes low-cost index funds from most major asset classes and risk categories. With Human Interest, you can have access to funds with highly competitive annual expense ratios, often without requiring substantial minimum account balances that might otherwise be necessary for institutional-class shares. These lower-cost funds can significantly reduce the impact of fees on your long-term investment growth.

Take the time to carefully review all the investment options available through your 401(k). Depending on your retirement saving strategy, tolerance to risk, and unique financial situation, you may benefit from an investment in index funds in small- and mid-cap domestic equities, foreign equities, bond markets, or real estate investment trusts.