Total Market versus S&P 500

[Austin_Explorer]

I've heard several members here sing the praises of the Vanguard Total Stock Market Index Fund. When I compare that fund against the Vanguard S&P 500 Index there does not appear to be much of a difference at all. They appear to move in lockstep with each other, have almost exactly the same beta, have almost exactly the same yield, etc. Also the S&P fund has slightly lower expenses if I just look at the total market fund classes that don't require a minimum of $250,000.

So, what's your overriding factor makes the total market fund better than the S&P 500?

 

[retire@40]

You might see a difference if small caps outperform or underperform large caps since the S & P 500 is mostly large cap and Total Market is large and small cap.

 

[azanon]

S&P500 is large-cap blend whereas (i assume) total stock market index would include all market capitalizations (large, mide, small) at all valuations (growth, value, blend). I don't know that one's "better" than the other, but i'm sure the debate will be never ending as to whether large-caps or small-caps are better or not.

It depends on the condition of the market at the time as to which is better but, naturally, the total stock index would involve more diversification. If i could only pick one fund, i'd go with total stock market index so i could also own mid/small caps.

 

[sgeeeee]

Both of the previous posters have given you the correct answer. TSM provides more exposure to small-cap markets than S&P 500. A few years ago, Jack Bogle started saying that most investors would be better off investing in TSM over S&P 500. Although through many periods of time, the difference would be insignificant, there have been several periods in the past when an investor would have been better served by exposure to more small-caps. This thinking is also in agreement with most of the modern writings about asset allocation. (ie Bernstein, etc.)

An investor could buy S&P 500 plus add their own small cap funds or investments to get the same effect, but TSM seems like an easy way to gain some stability through appropriate asset allocation advantage that S&P 500 doesn't offer.

 

[Austin_Explorer]

I agree that the TSM index SHOULD be better, but is it really? Since on average smaller cap stocks perform better than large cap (if not, why would anyone bother putting money into riskier, smaller companies?), I expected to see a larger difference.

VFINX's top 10 holdings comprise of 22.21% of total assets, whereas VITSX's top 10 comprise 17.21% of total assets. I just would have expected a bigger difference in performance over the years instead of the lock step in which they appear to be.

 

[ats5g]

Does the Total Stock Market fund include small caps, yes? Do those small caps have much of an affect on the performance of that fund vs. VFINX? Not really b/c the TSM fund only includes a very small % of small caps. When small outperforms large, TSM should outperform VFINX by around 1-3% in that year, depending on how much small outperforms large. And likewise, when large outperforms small, VFINX should outperform TSM by 1-3% in that years, depending on how much small outperforms large.

Also remember that the majority of the small cap premium was in the micro caps, which TSM includes very few of. So TSM doesn't get that much of a boost from the small caps it includes. When people like Ibbotson, Bernstein, and others talk about small caps, they mean the smallest 20% or the smallest 2 deciles by market capitalization, not the Russell 2000 or S&P 600, which include larger stocks as well - what academics would call "mid caps". The definitions of small caps, mid caps, large caps, value, blend, and growth vary depending on whether you talk to M* or academics.

TSM also doesn't rebalance b/w small caps and large caps. It just lets the large, mid, small %'s change as the market capitalizations of each stock changes. For example, when large outperforms small by a lot (like in the 1990's), large caps begin to make up a higher % of the TSM fund. When small does better than large, small caps begin to make up a higher % of the TSM fund.

The reason for the inclusion of small caps is their non-perfect correlation with large caps. Even thought small caps are riskier by themselves, we should only care about by how much their inclusion in our portfolios either increases or decreases our our portfolios' risk. Small caps may or may not outperform large caps in the future [likewise foreign stocks may or may not outperform], but I'd rather include both small caps and large caps and not bet either way.

The advantage of TSM is that it really never has to buy and sell stocks, except when there is a merger or something. So, it should have slighly lower turnover than the S&P 500 fund. Also, let's say that the S&P committee (which chooses the 500 stocks for its large cap index) overlooks a company that turns out to be a steller stock performer. It's very likely that the TSM fund does include that stock.

- Alec

 

[Whakamole]

VTSMX portfolio:

Giant 40.43
Large 30.68
Medium 19.74
Small 6.67
Micro 2.49

VFINX (S&P 500) portfolio:
Giant 51.89
Large 37.75
Medium 10.24
Small 0.12
Micro 0.00

It's not a significant stake. I'd rather just invest in small caps myself, and get a larger stake.

 

[Austin_Explorer]

Whakamole,

Thanks for the stats. It confirms what I thought, that the total market index is also somewhat heavy in large cap stocks. Certainly for safer portfolios that makes a lot of sense, but if one wants a bit more of the small cap upside they'd have to augment that with some additional small caps elsewhere.

 

[cute fuzzy bunny]

You could split between the s&p 500 and the 'extended market' or 'wilshire 4500' index, which is the rest of the wilshire 5000 (actually closer to 7000). Do check on that wilshire 4500 index funds costs first though, last time I owned vanguards (~1998) it charged a small fee either going in or coming out, and you had to own the shares for a certain period of time.

If you look at it in 20-30 year chunks, the TSM usually has a slightly lower return than the S&p500, with slightly less volatility. Note its been a year or two since I did that analysis.

If I remember correctly, TSM indexes really CANT take a large proportional holding in small and medium sized companies simply because there isnt enough liquidity or total shares in those companies to feed the demand. Heck if they included a thousand microcaps, its possible all the shares of those microcaps would be suctioned into TSM index funds.

Note also that its my opinion that both the s&p500 and the TSM are overvalued right now, which makes me hesitant to recommend them or any composite fund that uses either as a core holding. But for all I know, it'll keep going up 20% a year for another 10 years. But that doesnt mean theres any reasonable basis for that to happen. I'm still liking value stocks...they dont have as far to fall and the dividends help pump up the return.

 

[Nords]

Perhaps a better comparison...

... would be to evaluate the record of the following ETFs:

S&P 1500 (iShares' version of the TSM) (ISI, 0.20% ER)
vs
the combination of the three funds for the
S&P500 (IVV, 0.09%)
S&P400 (IJH, 0.20%)
S&P600 (IJR, 0.20%).

The appeal is in the simplicity-- maybe I should call Harvard and underbid their current trust-fund administrator. Unfortunately the actual ISI was only started up in Jan and the other three have only been around for four years. Comparisons would have to depend on data-mining backtesting.

It's interesting to note that buying the TSM the "hard way" actually results in a lower ER-- 0.163 vice 0.20. Sounds like splitting hairs but on the typical $10K investment that's $3.67 per year!

 

[cute fuzzy bunny]

Which is three, count em, three, jack in the box "big cheeseburgers". The best fast food deal going, imo...

 

[wabmester]

The best fast food deal going, imo...

The only fast food we have in town is a McD.   Double cheeseburger and a hot fudge sundae for $2.   Mmmm, mmmm.   (I'm on a diet, so I don't eat the bun  )

 

[cute fuzzy bunny]

The big cheeseburger is bigger than a quarter pounder, and has two pieces of cheese. Depending on which jack-in-the-box you go to, they're between 99c and 1.29.

Their jalapeno poppers are good too...dont know if they have those outside the southwest or not.

 

[ESRBob]

Austin-Explorer;
Cheeseburgers aside
I agree with TH that and ats5g that if you want small cap exposure then you probably want it in its own fund, preferably a value fund. From the Modern Portfolio THeory pov, (looking at the performance of the oveall portfolio and trying to keep its return up or less volatile with asset classes that are less correlated), you would want more small cap than would be represented in the total market capitalization. So we go directly to vanguard and DFA's small cap value and microcap funds in amounts much bigger than their market cap weighting. Specifically, we have 10% of our total portfolio (25% of our equity portfolio) in US Small Cap Value Tilt and another 10% of the total portfolio (25% of the equity) in international small cap. By splitting between large and small cap stocks on a 50%-50% basis, we are way overweight (from the 9% or so in the overall market cap that Whackamole gave us). I got ther by following Bernstein and running lots of scnarios. As an aside, it makes most of the calculators, like FireCalc, of limited use for me since they seldom contain a small cap series, much less a small cap value series, but I am sure this will change over time.

Also remember that small cap are not squirrelly little 10 million dollar sales companies -- small cap are variously defined as the bottom 10% or bottom 20% of the NYSE stocks, plus others around that size on Nasdaq. (Micro-caps would be the smaller ones). So these are billion dollar companies in many cases -- not fly-by-nights, and statistically over long periods they deliver awesome returns (US Small Cap Value have returned 14.2% between 1927 and 2002 - source DFA Yearbook). For those who like big numbers, that means one dollar grew to $24,945 over that 75 year period in nominal terms. In contrast, US Large Growth returned 9.4% and a dollar grew to $931 over the same period.

 

[wabmester]

If you believe in the idea of efficient markets, and you believe in the idea of passive low-cost investing, you might consider owning TSM exclusively for your US stock exposure.

TSM represents the cap-weighted holdings of the entire US market (thus the name).   It is the easiest way for you to allocate your capital in the same manner as all  the world's experts have allocated their capital.   No need to guess which category of stocks is going to outperform --- others have already made their bets for you.   Buying TSM simply allows you to ride their coat-tails.

And as Alec mentioned, the costs of holding the fund are intrinsically lower than other funds since there is no need for the fund managers to ever rebalance.