Vanguard’s S&P and Total Market Funds: Soul Brothers or Twins by Steve Abramowitz

Investors who desire a broader market index fund than is offered by the 500 large-cap stocks in the S&P Index Fund often opt for the 3,500 or so stocks in the ostensibly more encompassing Total Market Index Fund. But are these two funds—among the largest on the mutual fund landscape– really all that different?  Let’s find out.

The Portfolios

It makes sense to begin our investigation of just how alike the S&P surrogate and Total Market Index are by comparing several characteristics of their portfolios. In many ways, the two funds are exactly the same. Cost at .04 is trademark Vanguard. Perhaps surprisingly, the ten largest holdings of the funds are identical and those ten account for about one-third of the size of their entire portfolios.

Looking within the funds themselves, we note very few small stocks according to Morningstar’s criteria. Small companies constitute only 8% of the whole market fund and absolutely none appear in the S&P 500 proxy. We might have expected an absence of small stocks in a fund comprised of 500 of the largest stocks in the country, but why hardly any in a fund purportedly representing the entire market?

In that circumstance, we might anticipate that Morningstar characterizes both funds as consisting of large cap stocks that roughly blend across both growth and value investment styles. Even more, the dividend yield is 1.4% for both index funds, which turn over an identical 2% of its holdings a year.

We can borrow from science a statistic known as correlation to see the extent to which the two funds move up and down together. A correlation of 1.00 indicates perfect synchrony, whereas -1.00 signifies that the two funds move in precisely opposite directions. A zero number indicates that movement higher or lower in one fund is unrelated to swings in the other. I was dumbfounded to learn that the correlation between the two funds is an almost perfect .99.  Whenever one of these guys goes up, the other follows. Always.

Performance

So far, our S&P proxy and broad market fund look astonishingly (shockingly?) alike. But here we encounter a disparity that on first blush may seem small, but in the present market environment becomes a distinguishing factor driving the funds’ relative success. The S&P Index Fund has a technology weighting of 34%, while the same figure for its comparison fund is 32%. More telling, 39% of the stocks in the S&P surrogate were classified as large growth, 4% more than those in the broad market. And large cap growth stocks, which include most of those  benefiting from the artificial Intelligence craze, have been where all the action was in the first half of this year.

But does the slightly higher proportion of large growth stocks in the S&P 500 Index Fund  matter in the real world? Well, let’s take a look. Year-to-date through June, the S&P Index Fund gained 15.3% as against 13.6% for its total market companion. And over the more reliable last three years, the average annual difference reached 10% relative to 7.9%. This discrepancy may look innocent enough, but with compounding it becomes substantial. In the last ten years, the all-market fund turned $10,000 into about $33,800, but the S&P proxy grew $2,000 more.

Imagine what this snowballing would mean for a person still in the accumulation phase. If this difference were to persist and compound at the market’s annual average 10% return for, say, 35 years until retirement at age 65, that seemingly innocuous gap would grow to over $66,000.

But we have a hint that the differential investment outcome is likely to persist only as long as  large cap growth continues to dominate. Remember our S&P proxy is overweight technology and other high-octane large cap growth stocks, a situation unlikely to prevail indefinitely. But until it does, the fund’s stronger performance could endure.

Risk

Gains have recently been greater for the S&P Index Fund than its presumably broader market counterpart. But what about risk, which usually accompanies better performance? We find the portfolios’ riskiness to be very much alike despite the small outperformance of the S&P tracking fund. How so? During the brutal bear market ushered in by the pandemic, our S&P surrogate declined 25% and the whole market fund 26%. Both categorized as aggressive and assigned an identical risk score by Morningstar, the funds fared like clones at 26% in the market’s 2023 recovery. Total Market declined -20% compared to the S&P index’s -18% in the 2022 bear, suggesting a small difference in their vulnerability to market reversals.

The two funds frequently used as the core holding of the U.S. portion of portfolios are indeed very much the same except for one meaningful difference. The fund that tracks the S&P contains more large cap growth stocks than its total market sibling, and therein lies the source of its modestly superior results.

Takeaways

A reasonable question to ask is whether the small difference in favor of the index-based S&P is actionable. I think it is. Don’t fool yourself into thinking that either fund is truly diversified–you are without the universe of small companies. Fortunately, you can easily fill that hole with the Vanguard Small Cap Index Fund.

Owning both of our target funds is merely duplicative and only complicates matters for you and your heirs. In the market’s current mood, you will likely outperform in the S&P, but this could turn on a dime. Whether these core funds are just soul brothers or virtually identical is for you to decide.