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In The Bogleheads’ Guide to the Three-Fund Portfolio, Taylor Larimore gives several reasons for why index funds are better investment vehicles than individual stocks for most investors:
1. Index funds outperform most individual stocks over the long haul.
2. Index funds often have low fees, which means investors keep more money in their pockets and pay out less to active managers.
3. Index funds offer maximum diversification through holding thousands of individual stocks.
Larimore explains that investors can get the benefits of index-fund investing through owning one simple fund: A total stock market index fund. By owning this one index fund, you can own a piece of every publicly traded stock in the U.S.
However, investing titan Warren Buffett frequently recommends a different index fund for the average investor: a low-cost S&P 500 index fund.
Related Post: Here’s How the S&P 500 Has Performed Since 1928
So, if you want to keep investing as simple as possible and only invest in one stock market index fund, should it be a total stock market index fund or a S&P 500 index fund?
To answer this question, let’s compare two mutual funds offered by Vanguard:
VTSAX – Vanguard Total Stock Market Index Fund Admiral Shares
VFIAX – Vanguard 500 Index Fund Admiral Shares
First we’ll look at some basic information about each fund, then we’ll compare their composition, then we’ll finish by looking at their historical performance.
Let’s jump in!
Note: No matter which fund you choose to invest in, I highly recommend using Personal Capital to track your investments. It’s a completely free tool that makes it easy to track the value of your investments and ensures that you’re paying the lowest fees possible.
Comparing VTSAX vs. VFIAX
First, let’s check out some basic information about each fund:
|Fund Type||Mutual Fund||Mutual Fund|
|Number of Stocks||3,637||509|
|Category||Large Blend||Large Blend|
We can see that both funds are mutual funds, both have an expense ratio of 0.04% (if you invest $10,000 into either fund you will pay $4 each year in management expenses), both require a minimum investment of $3,000, and both are classified as “large blend” funds.
There are only two differences between the two funds:
1. VTSAX is composed of 3,637 individual stocks, compared to just 509 for VFIAX.
2. The dividend yield for VTSAX (1.82%) is slightly lower than that of VFIAX (1.93%), which could make a small difference for investors who are looking for higher-yielding funds.
The biggest difference between these two funds is their composition: VTSAX holds far more stocks than VFIAX. So, let’s take a look at this difference in composition and see if it impacts performance at all.
VTSAX vs. VFIAX: Differences in Composition
As the name suggests, the S&P 500 is composed of the largest 500 publicly traded companies in the U.S. There are 509 stocks in the index, though, because some companies have more than one “class” of stock. For example, Berkshire Hathaway has class A and class B shares. Thus, VFIAX is composed of the 509 largest stocks in the U.S.
On the other hand, VTSAX is composed of every single publicly traded stock in the U.S. At the time of this writing, that amounts to 3,637 individual stocks.
This means that VFIAX is just a subset of VTSAX. That is, VTSAX includes all 509 stocks that are in VFIAX as well as an additional 3,128 smaller stocks.
These 3,128 smaller stocks are known as mid-cap and small-cap stocks since their market capitalizations are smaller than the large-cap stocks in the S&P 500 index fund.
It’s important to note that since VTSAX is market-cap weighted, the 3,128 smaller stocks actually only comprise a small portion of the total fund. In fact, about 75% of VTSAX is composed of stocks in the S&P 500.
In addition, most people don’t realize just how large the largest stocks in the S&P 500 are relative to the other stocks in the index. For example, at the time of this writing the top 10 holdings for VFIAX account for 22.7% of the entire fund:
To further understand just how massive the largest stocks are relative to all other stocks, check out this interactive visualization that lets you see how large the biggest stocks are relative to the smallest stocks in terms of market cap.
This illustrates why the additional 3,128 stocks in VTSAX that are not in VFIAX don’t make a huge difference in terms of composition because these stocks are just so small relative to the biggest stocks in the S&P 500.
This also explains why both funds are classified as “large blend” index funds. VFIAX contains only large-cap stocks and since VTSAX is market-cap weighted, it’s composed of about 75% large-cap stocks.
Nonetheless, the two funds do have different compositions so let’s see if this difference impacts the annual returns.
VTSAX vs. VFIAX: Differences in Performance
The following table from Paul Merriman shows the annualized returns for the S&P 500 vs. the total stock market for each decade dating from 1930 to 2013:
|S&P 500 Index||-0.1%||9.2%||19.4%||7.8%||5.9%||17.5%||18.2%||-0.9%||9.7%|
|Total Stock Market||-0.2%||9.6%||18.2%||8.3%||6.1%||16.7%||18.0%||-0.3%||9.7%|
As you can see, the two indices offer extremely similar returns. In some decades, the S&P 500 outperforms and in others the total stock market outperforms. The two indices diverged the most in the 1950s when the S&P 500 provided 1.2% higher annual returns compared to the total stock market. Outside of that decade, though, both indices offered returns within 1% of each other.
Incredibly, from 1930 to 2013 the two indices both offered 9.7% annual returns (assuming dividends reinvested).
These results aren’t terribly surprising. The S&P 500 and the total stock market have a very similar composition and so their performance over the years has been very similar.
VTSAX vs. VFIAX: Which Should You Invest in?
We’ve seen that the biggest difference between VTSAX and VFIAX lies in their composition. VTSAX holds every publicly traded stock in the U.S. while VFIAX simply holds the largest 509 stocks. Because of the market-cap weighted nature of the funds, though, the composition of each fund is actually quite similar. Thus, the performance over the years has been nearly identical for each fund.
I personally prefer to invest in total stock market funds since they offer slightly more diversification with mid-cap and small-cap stocks. However, if you’re even debating whether you should invest in VTSAX or VFIAX, that’s an indication that you have your financial life in order.
Although the past can’t predict the future, more than likely each of these funds will provide similar returns in the coming years. The good news for investors is that both funds have extremely low expense ratios and both funds offer investment diversification for the average investor.
One last thing to mention is that there are equivalent ETF versions of each of these index funds that don’t require a minimum $3,000 investment. The ticker symbols for those ETFs are VTI (Vanguard Total Stock Market ETF) and VOO (Vanguard S&P 500 ETF) and I wrote an entire post where I compared the two as investment vehicles.
No matter which funds you decided to invest in, I recommend using Personal Capital to track your investments with their free Investment Checkup tool and Retirement Planner. It’s a completely free platform and it’s the only one I personally use on a monthly basis.
Zach is the author behind Four Pillar Freedom, a blog that teaches you how to build wealth and gain freedom in life.
Zach's favorite free financial tool he's been using since 2015 to manage his net worth is Personal Capital. Each month he uses their free Investment Checkup tool and Retirement Planner to track his investments and ensure that he's on the fast track to financial freedom.
Although the bulk of his net worth is invested in index funds, his favorite place to invest in individual stocks is M1 Finance, a site that allows you to build a custom portfolio of stocks for free.
His favorite way to save money each month on his recurring bills is by using Trim, a free financial app that negotiates lower cable, internet, and phone bills with any provider on your behalf.
His favorite micro-investing app is Acorns, a free financial app that takes just 5 minutes to set up and allows you to invest your spare change in a diversified portfolio.
His favorite place to find new personal finance articles to read is Collecting Wisdom, a site that collects the best personal finance articles floating around the web on a daily basis.
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