Better buy: Vanguard Total Stock Market ETF or Vanguard S&P500 ETF?

Many investors buy into the idea of ​​index investing, but figuring out which index fund to own can be a little paralyzing.

There are two general recommendations: Vanguard Total Stock Market ETF (VTI -0.06%) And that Vanguard S&P 500 ETF (VOO -0.10%). Both Vanguard funds are highly regarded by index investors due to their low expense ratios and strong track records in matching their respective indexes. Both can be excellent foundations for your portfolio.

The difference between the two is which index is tracked. The Total Stock Market Fund is CRSP US Total Market Index, covers nearly every investable U.S. stock on the market. The S&P 500 ETF is S&P500It’s a compilation of about 500 of the largest companies in the U.S. that have consistently posted profits for at least a year.

Deciding between the two can be difficult. So here’s what you need to know.

Image source: Getty Images.

There is a lot of overlap between funds

Both funds are weighted by market capitalization. This means that America’s largest companies: microsoft and apple Both account for a large share of the portfolio. On the other hand, smaller companies, such as his No. 500 from No. 491 on the S&P 500, account for a much smaller share. As a result, there is a lot of overlap between the Vanguard Total Stock Market ETF and the Vanguard S&P 500 ETF.

The top 10 stocks held by each fund are the same. They are listed below and their respective weights.

Data source: Vanguard. Data as of March 31, 2024.

Overall, 86% of the Total Stock Market ETF’s holdings overlap with the S&P 500 ETF’s holdings. As a result, the expected returns are very similar and highly correlated.

This results in 14% of the entire stock market ETF being invested in stocks outside the S&P 500 index. These are small- and medium-sized stocks, or large companies that have not yet met the profitability criteria for inclusion in the S&P 500 index. Although this degree of dispersion is not significant, it does not mean that the Total Stock Market ETF’s returns will deviate significantly from the S&P 500 ETF’s returns.

Factors to consider in every ETF

However, there are some other important factors to consider. Let’s look at it in the context of the Vanguard Total Stock Market ETF and the Vanguard S&P 500 ETF.

• Expense ratio: Expense ratio is the amount you pay as a percentage of your assets invested in a particular fund. Most index funds have very low expense ratios because you don’t have to pay a fund manager to actively select individual stocks. Index funds simply respond to the market and the S&P selection committee. Both ETFs have expense ratios of just 0.03%.

• Turnover: Turnover is a measure of what percentage of assets a fund manager sells in a particular year. A high turnover rate may indicate that the index fund is poorly managed. Selling a stock typically results in a taxable event, but ETFs have mechanisms to avoid incurring a tax liability. Volume for both ETFs in 2023 was just 2.2%.

• Tracking error: Tracking error measures how well an ETF’s price reflects the value of the underlying index at a given time. If the tracking error is large, individual returns may not match the promise of the index fund, and therefore may not match the market. If an investor buys an ETF when the price is above the index and sells when the price is below the index, it can incur costs that exceed the expense ratio. The Vanguard S&P 500 ETF manages a lower tracking error than the Vanguard Total Stock Market ETF: 0.02% vs. 0.05%. However, neither outcome is cause for concern.

It may be reasonable to own both.

You can’t go wrong with either the Vanguard Total Stock Market ETF or the Vanguard S&P 500 ETF. Both have very low expense and turnover ratios, and the difference in tracking error is negligible. The overlapping asset holdings of both companies ensure similar returns going forward. Adding exposure to small- and mid-cap stocks through the Total Stock Market ETF certainly increases expected returns, but it can take a very long time to materialize.

If you want to add exposure to small- and mid-cap stocks, but not as much as the Vanguard Total Stock Market ETF, you can simply buy both. If you split your money evenly between the two, most of your investment would be in large-cap stocks, but about 7% would be in small- and mid-cap stocks outside of the S&P 500. However, you can divide the funds as you like. You may need to rebalance from time to time, but each fund’s returns are very similar, so you won’t deviate too much from your target allocation.

As it turns out, either or both funds could be a great cornerstone of your portfolio.