Question: I'm trying to decide which would make a better holding for the core U.S. equity portion of my portfolio: an S&P 500 index fund or a total stock market index fund. What should I take into consideration?
Answer: Since the advent of exchange-traded funds, a lot of Canadian investors have chosen to go the index route for their U.S. equity exposure, so many of you likely have the same question.
For those who might be unfamiliar with the two index types mentioned, the S&P 500 tracks 500 of the largest U.S. stocks as measured by the value of their shares. Because the index is weighted by market capitalization -- the number of shares on the market times share price -- higher-value companies take up bigger weightings and lower-value companies take up smaller positions. The overwhelming majority of ETF assets in the U.S. Equity category are invested in ETFs that track this index.
Total stock market funds, on the other hand, include both large-cap stocks and the many small- and mid-cap stocks left out of the S&P 500. Total market funds typically track an index such as the MSCI U.S. Broad Market Index or Dow Jones U.S. Total Stock Market Index, which also are cap-weighted and which attempt to measure the performance of all publicly traded U.S. stocks. To help answer your question about which is the better choice for you, let's look at key differences between these two widely used index fund types.
Composition differences
As we've said, a total stock market index fund encompasses a wider universe of stocks than does the S&P 500, but the difference might not be as great as you think. Stocks in the S&P 500 make up about 80% of the total U.S. equity market capitalization, so the overlap is considerable. That said, the roughly 20% of the market capitalization that is found only in the total stock market index fund does provide greater diversification because of the presence of smaller stocks. For investors with small-cap exposure elsewhere in their portfolios, the large- and mid-cap S&P 500 fund may suffice. But for a broader, one-stop-shopping fund, the total market index offers maximum diversification within the U.S. equity universe.
To illustrate the difference in the composition of these indexes, let's examine the portfolios of two funds that track them. The portfolio of iShares S&P 500 IndexXUS, which follows the S&P 500, has an average market cap of $65.7 billion. By contrast, Vanguard U.S. Total Market ETFVUN, which follows the CRSP U.S. Total Market Index, has a smaller average market cap of $35.7 billion.
Also worth noting, though it plays a much smaller role in distinguishing the index fund types from one another, is the fact that the S&P 500 is not a purely cap-determined index. A committee of economists and analysts at Standard & Poor's maintains the index and may exclude companies for a variety of reasons, including that a company is no longer considered financially viable as a result of ongoing losses, that the company's stock is not liquid enough, or because the stock throws off the index's sector balance. In September, Standard & Poor's announced it was dropping Advanced Micro DevicesAMD out of the index because its market valuation is too small (AMD was added to the S&P MidCap 400 Index). The CRSP U.S. Total Market Index, however, tracks nearly all publicly available equities that meet minimum liquidity requirements, which equates to roughly 3,600 securities.
Yet another factor at play here is the fact that S&P 500 stocks tend to be widely available, making it relatively easy for funds to track the index. Total stock market indexes, on the other hand, include some of the smallest publicly traded issues, which are cost-prohibitive for fund companies to buy and sell. To help minimize this added trading cost, total market funds might employ a representative sampling method to approximate an index's performance so that they don't have to trade each and every stock in it.
Performance varies slightly
So how do S&P 500 and total U.S. stock market index funds compare in terms of performance? The short answer is not all that differently. Below is a table that shows annualized performance for each fund type during various time periods. Note that since the Canadian version of the Vanguard total market ETF was only launched in August 2013, this comparison looks at the numbers for the U.S. versions of these funds, which have rock-bottom fees and lengthy track records. These returns are in U.S. dollars.
As you can see, the total stock market fund has performed slightly better, but volatility should also be taken into consideration, given that small-cap stocks tend to provide a bumpier ride than large caps. The large-cap-heavy Vanguard 500 fund has a 10-year standard deviation -- a measure of volatility -- of 14.7, whereas Vanguard Total Stock Market has a 10-year standard deviation of 15.2. So by including smaller stocks, the total market fund also increases its overall volatility, albeit just slightly.
The bottom line
S&P 500 and total stock market index funds and ETFs are great ways for investors interested in using a passive investment strategy to own a broadly diversified basket of U.S. stocks. As a bonus, these index funds often charge some of the lowest fees in the investing marketplace. As for which type of index fund best suits your needs, it ultimately comes down to whether you're willing to accept a small step up in volatility with a total market index fund for a potential small step up in performance. That's an individual choice, of course, but a question well worth asking.
FAQs
As a result, an S&P 500 fund has a higher potential for returns based on the performance of the top US companies. In the long-term, however, a total stock market index fund has the potential to generate higher returns than an S&P 500 fund.
Should I buy S&P 500 or Total market? ›
You can't go wrong with either the Vanguard Total Stock Market ETF or the Vanguard S&P 500 ETF. Both offer very low expense ratios and turnover rates, and the difference in their tracking errors is negligible. The overlap in their holdings ensures that you'll get very similar returns going forward.
Which index to follow for US stock market? ›
For insights on the US stock exchange and economy, follow indexes like S&P 500, Nasdaq Composite, and Dow Jones Industrial Average.
Is it better to track the Dow Jones or S&P 500? ›
He added that Dow Jones is "a great guide" for an average investor, but the S&P 500 and the Nasdaq are "probably a better reflection" of the stock market and the U.S. economy because of the number of stocks they track.
What is the difference between the S&P 500 and the US stock market? ›
The Dow tracks 30 large U.S. companies but has limited representation. The Nasdaq indexes, associated with the Nasdaq exchange, focus more heavily on tech and other stocks. The S&P 500, with 500 large U.S. companies, offers a more comprehensive market view, weighted by market capitalization.
Is it better to buy S&P 500 or individual stocks? ›
Is Investing in the S&P 500 Less Risky Than Buying a Single Stock? Generally, yes. The S&P 500 is considered well-diversified by sector, which means it includes stocks in all major areas, including technology and consumer discretionary—meaning declines in some sectors may be offset by gains in other sectors.
Is it wise to only invest in S&P 500? ›
Meanwhile, if you only invest in S&P 500 ETFs, you won't beat the broad market. Rather, you can expect your portfolio's performance to be in line with that of the broad market. But that's not necessarily a bad thing. See, over the past 50 years, the S&P 500 has delivered an average annual 10% return.
What is the most accurate Stock Market Index? ›
Like the Dow Jones and the Nasdaq composite, the S&P 500 is an index of stocks. The S&P is considered by many investors to be the most accurate representation of how the overall stock market is performing, as it uses 500 stocks chosen based on size, industry and other factors to reflect a wide swath of industries.
What are the top 3 US indexes? ›
In the United States, the three leading stock indexes are the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite.
Which index covers all US stocks? ›
The Dow Jones U.S. Total Stock Market Index, a member of the Dow Jones Total Stock Market Indices family, is designed to measure all U.S. equity issues with readily available prices.
Because the S&P 5 0 0 has a greater number of companies and covers a wider range of industries, providing a more diverse and representative sample of the market.
Why does the Dow outperform the S&P? ›
In these circ*mstances, one contributing factor is that historically The Dow has been somewhat more value-oriented, tracking well-established large-cap companies whose prices can tend to be less volatile. The S&P 500, while more diversified than The Dow, is sometimes more volatile.
Is there anything better than the S&P 500? ›
The S&P 500's track record is impressive, but the Vanguard Growth ETF has outperformed it. The Vanguard Growth ETF leans heavily toward tech businesses that exhibit faster revenue and earnings gains. No matter what investments you choose, it's always smart to keep a long-term mindset.
Should I invest in Total market or S&P 500? ›
For investors with small-cap exposure elsewhere in their portfolios, the large- and mid-cap S&P 500 fund may suffice. But for a broader, one-stop-shopping fund, the total market index offers maximum diversification within the U.S. equity universe.
What is the best total market index fund? ›
Best Total Market Funds
| Fund | Ticker | Expense Ratio % |
|---|
| iShares Core S&P Total US Stock Market ETF | ITOT | 0.03 |
| Schwab Total Stock Market | SWTSX | 0.03 |
| Vanguard Total ETF | VTI | 0.03 |
| Vanguard Total Admiral | VTSAX | 0.04 |
2 more rowsMar 18, 2024
It is float-adjusted and calculated using a proprietary index divisor developed by Standard & Poor's. A downside to the index is that it is weighted toward large-cap stocks. The S&P 500 covers most areas of the U.S. market, encompassing roughly 80% of the available market cap.
Is it worth investing in S&P 500 right now? ›
The S&P 500 is less than 3% away from its all-time high, making some investors hesitant to buy an index fund. There's no way to time a correction, and even if you buy at the highs, you'll likely do fine over the long run. Dollar-cost averaging could be a far better strategy, no matter what the market is doing.
What is the S&P 500 market cap vs total market cap? ›
The S&P 500 has a market capitalization of $43.908 trillion dollars. The total market cap is calculated by summing the market capitalization of every company in the index. Each company's calculated market cap is based on the outstanding float share count.
Do most investors beat the S&P 500? ›
The phrase "beating the market" means earning an investment return that exceeds the performance of the Standard & Poor's 500 index. Commonly called the S&P 500, it's one of the most popular benchmarks of the overall U.S. stock market performance. Everybody tries to beat it, but few succeed.
Should I invest $100 in S&P 500? ›
Many consider this a 'boring investment,' but the results the index has produced are nothing to balk at. The average yearly return of the S&P 500 over the last 30 years is 10.7%, but even at a conservative return of 8%, you would have over $146,000 if you invest $100 a month for 30 years.
