diff --git a/lib/markdown/link.js b/lib/markdown/link.js
index 99ca1aefd9..bbe9550d63 100644
--- a/lib/markdown/link.js
+++ b/lib/markdown/link.js
@@ -2,6 +2,8 @@
 // 1. adding target="_blank" to external links
 // 2. converting internal links to <router-link>
 
+const indexRE = /(.*)(index|readme).md(#?.*)$/i
+
 module.exports = (md, externalAttrs) => {
   let hasOpenRouterLink = false
   let hasOpenExternalLink = false
@@ -37,15 +39,28 @@ module.exports = (md, externalAttrs) => {
     const links = md.__data.links || (md.__data.links = [])
     links.push(to)
 
-    to = to
-      .replace(/\.md$/, '.html')
-      .replace(/\.md(#.*)$/, '.html$1')
-    // normalize links to README/index
-    if (/^index|readme\.html/i.test(to)) {
-      to = '/'
+    const indexMatch = to.match(indexRE)
+    if (indexMatch) {
+      const [, path, , hash] = indexMatch
+      to = path + hash
+    } else {
+      to = to
+        .replace(/\.md$/, '.html')
+        .replace(/\.md(#.*)$/, '.html$1')
+    }
+
+    // relative path usage.
+    if (!to.startsWith('/')) {
+      to = ensureBeginningDotSlash(to)
     }
+
     // markdown-it encodes the uri
     link[1] = decodeURI(to)
+
+    // export the router links for testing
+    const routerLinks = md.__data.routerLinks || (md.__data.routerLinks = [])
+    routerLinks.push(to)
+
     return Object.assign({}, token, {
       tag: 'router-link'
     })
@@ -65,3 +80,12 @@ module.exports = (md, externalAttrs) => {
     return self.renderToken(tokens, idx, options)
   }
 }
+
+const beginningSlashRE = /^\.\//
+
+function ensureBeginningDotSlash (path) {
+  if (beginningSlashRE.test(path)) {
+    return path
+  }
+  return './' + path
+}
diff --git a/test/markdown/__snapshots__/link.spec.js.snap b/test/markdown/__snapshots__/link.spec.js.snap
new file mode 100644
index 0000000000..930f5e3575
--- /dev/null
+++ b/test/markdown/__snapshots__/link.spec.js.snap
@@ -0,0 +1,25 @@
+// Jest Snapshot v1, https://goo.gl/fbAQLP
+
+exports[`link should render external links correctly 1`] = `
+<p>
+  <a href="https://vuejs.org/" target="_blank" rel="noopener noreferrer">vue
+    <OutboundLink/>
+  </a>
+</p>
+`;
+
+exports[`link should render external links correctly 2`] = `
+<p>
+  <a href="http://vuejs.org/" target="_blank" rel="noopener noreferrer">vue
+    <OutboundLink/>
+  </a>
+</p>
+`;
+
+exports[`link should render external links correctly 3`] = `
+<p>
+  <a href="https://google.com" target="_blank" rel="noopener noreferrer">some <strong>link</strong> with <code>code</code>
+    <OutboundLink/>
+  </a>
+</p>
+`;
diff --git a/test/markdown/link.spec.js b/test/markdown/link.spec.js
new file mode 100644
index 0000000000..620c9fa488
--- /dev/null
+++ b/test/markdown/link.spec.js
@@ -0,0 +1,77 @@
+import { Md } from './util'
+import link from '@/markdown/link.js'
+import { dataReturnable } from '@/markdown/index.js'
+
+const mdL = Md().use(link, {
+  target: '_blank',
+  rel: 'noopener noreferrer'
+})
+
+dataReturnable(mdL)
+
+const internalLinkAsserts = {
+  // START abosolute path usage
+  '/': '/',
+
+  '/foo/': '/foo/',
+  '/foo/#hash': '/foo/#hash',
+
+  '/foo/two.md': '/foo/two.html',
+  '/foo/two.html': '/foo/two.html',
+  // END abosolute path usage
+
+  // START relative path usage
+  'README.md': './',
+  './README.md': './',
+
+  'index.md': './',
+  './index.md': './',
+
+  'one.md': './one.html',
+  './one.md': './one.html',
+
+  'foo/README.md': './foo/',
+  './foo/README.md': './foo/',
+
+  'foo/README.md#hash': './foo/#hash',
+  './foo/README.md#hash': './foo/#hash',
+
+  '../README.md': './../',
+  '../README.md#hash': './../#hash',
+
+  '../foo.md': './../foo.html',
+  '../foo.md#hash': './../foo.html#hash',
+
+  '../foo/one.md': './../foo/one.html',
+  '../foo/one.md#hash': './../foo/one.html#hash'
+  // END relative path usage
+}
+
+const externalLinks = [
+  '[vue](https://vuejs.org/)',
+  '[vue](http://vuejs.org/)',
+  '[some **link** with `code`](https://google.com)' // #496
+]
+
+describe('link', () => {
+  test('should convert internal links to router links correctly', () => {
+    for (const before in internalLinkAsserts) {
+      const input = `[${before}](${before})`
+      const output = mdL.render(input)
+      const after = getCompiledLink(output)
+      expect(after).toBe(internalLinkAsserts[before])
+    }
+  })
+
+  test('should render external links correctly', () => {
+    for (const link of externalLinks) {
+      const { html } = mdL.render(link)
+      expect(html).toMatchSnapshot()
+    }
+  })
+})
+
+function getCompiledLink (output) {
+  const { data: { routerLinks }} = output
+  return routerLinks[0]
+}