2 Vanguard Index Funds to Buy to Beat the S&P 500 in the Years Ahead, According to Wall Street Analysts

Morgan Stanley analysts led by Lisa Shalett expect the S&P 500 (SNPINDEX: ^GSPC) to return 6.3% annually over the next seven years. That would be substantially worse than the 15% annually we've had over the last seven years. But exceptionally high starting valuations are likely to be a major headwind in the future.

Indeed, the S&P 500 currently trades at one of its most expensive cyclically adjusted price-to-earnings (CAPE) ratios in history. That is particularly concerning because many experts believe the tariffs imposed by President Donald Trump will slow economic growth. But international stocks generally have more attractive valuations, so Morgan Stanley analysts see more upside in those markets.

Specifically, the analysts estimate that emerging-market equities will return 8.9% annually and Asia-Pacific equities will return 7.9% annually over the next seven years. Investors can position their portfolios to benefit by purchasing shares of the Vanguard FTSE Emerging Markets ETF (NYSEMKT: VWO) and the Vanguard FTSE Pacific ETF (NYSEMKT: VPL).

Here are the important details.

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Vanguard FTSE Emerging Markets ETF

The Vanguard FTSE Emerging Markets ETF measures the performance of 6,000 companies located in emerging markets, especially China, Taiwan, and India. The index fund is most heavily weighted toward stocks in three market sectors: technology, financials, and consumer discretionary. The top five positions are as follows:

1. Taiwan Semiconductor: 10.3%
2. Tencent Holdings: 4.5%
3. Alibaba Group: 3.2%
4. HDFC Bank: 1.1%
5. Reliance Industries: 1.1%

Importantly, while Morgan Stanley expects emerging-market equities to outperform the U.S. stock market in the next seven years, the exact opposite happened over the last seven years. The S&P 500 returned 198%, while the Vanguard FTSE Emerging Markets ETF returned just 71%.

The Vanguard index fund has an expense ratio of 0.07%, meaning shareholders will pay $7 per year on every $10,000 invested. That average expense ratio among similar funds is 1.2%, which makes this one a good option for investors who want exposure to the most important stocks across China, Taiwan, and India.

Vanguard FTSE Pacific ETF

The Vanguard FTSE Pacific ETF measures the performance of 2,300 companies located in Asia-Pacific countries, particularly Japan, Australia, and South Korea. The index fund is most heavily weighted toward stocks in three market sectors: financials, industrials, and consumer discretionary. The top five holdings are listed by weight below:

1. Samsung Electronics: 3.2%
2. Toyota Motor: 2.1%
3. SK Hynix: 1.9%
4. Sony Group: 1.7%
5. Mitsubishi UFJ Financial Group: 1.7%

Here again, while Morgan Stanley expects Asia-Pacific equities to outperform the U.S. stock market over the next seven years, the opposite happened over the last seven years. The S&P 500 returned 198%, while the Vanguard FTSE Pacific ETF returned 77%.

The Vanguard fund has an expense ratio of 0.07%, meaning shareholders will pay $7 per year on every $10,000 invested. The average expense ratio among similar funds is 0.68%, which makes this one a good option for investors who want exposure to the most important stocks across Japan, Australia, and South Korea.

Wall Street analysts are frequently wrong

Investors should never put too much confidence in Wall Street's forecasts because even the best analysts are frequently wrong. In the last five years, Wall Street's median year-end target for the S&P 500 missed the mark by an average of 18 percentage points, according to Goldman Sachs. If one-year forecasts are that hard to get right, Morgan Stanley's seven-year forecast could be wildly inaccurate.

What does that mean for investors? You should consider small positions in the index funds I have discussed, particularly the Vanguard Emerging Markets ETFs. However, I would keep a much larger percentage of my portfolio in an S&P 500 index fund or individual U.S. stocks. The S&P 500 crushed benchmarks for European, Asian, and emerging-market stocks in the last five, 10, and 20 years. I doubt that will change anytime soon.

Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group, Taiwan Semiconductor Manufacturing, Tencent, and Vanguard International Equity Index Funds-Vanguard Ftse Emerging Markets ETF. The Motley Fool recommends Alibaba Group and HDFC Bank. The Motley Fool has a disclosure policy.