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If you’ve ever wondered whether Vanguard’s S&P 500 or total stock market fund is the better core holding in your portfolio, you’re probably not alone. Each ETF has over 400 billion in net assets, each has an expense ratio of .03, each has essentially the same dividend (1.25%) and each is categorized by both Vanguard and Morningstar as large blend. Both funds trade at very high volume, making the spread on purchases and sales all but nonexistent. Most telling, The S&P 500 ETF (VOO; VFIAX as mutual fund) and total stock market ETF (VTI; VTSAX) correlate at an almost perfect .99. C’mon man, let’s not waste your time or mine, these guys are effectively identical.
In fact, they are very similar, close brothers, but not identical twins. For starters, you may recall that the total market fund is far more diversified (over 3,600 holdings) than the S&P 500. But you may not know that stocks in the market’s preferred benchmark have a median market capitalization of about 250 billion, considerably larger than the 175 billion of the broader market index. VTI is better-diversified and tends to hold smaller companies than VOO.
There’s more to munch on, beginning with size. According to Morningstar, midcap stocks comprise just 17% of Vanguard’s S&P 500 ETF and small caps none at all. The corresponding numbers for total stock market are 20% and 8%, leaving less room for larger stocks.
Now, let’s dig down to the ETFs’ investment style. The S&P proxy carries a higher percentage of growth names (40% vs. 35%), more technology (32% vs. 30%) and a larger proportion of assets in its top three tech holdings (20% vs. 17%). Vanguard’s total stock market fund’s portfolio is less likely to hold growth companies as well as more likely to own smaller stocks. The S&P not only has a higher percentage of larger stocks. Because of their size, those companies have a disproportionate impact on market capitalization and performance.
But performance is where the rubber meets the road. Can these small statistical disparities make a difference in the real world? Over the last ten years, our S&P surrogate had an average annual total return of 13.1%, notably higher than the broader market fund’s 12.5%. Obviously, both funds rode the wave of the market’s last ten years.
The S&P 500’s modest edge became substantial with an assist from compounding. A $10,000 lump sum investment over the last decade swelled to $40,100 in the S&P as compared to $37,800 for the total stock fund. Is that $2,300 profit just chump change? It’s not for me and probably not for you either.
For sure, some wise guy out there is going to say that’s just random because, in much of the 1970s and 1980s, smaller stocks bested their larger counterparts. The relative superiority of one fund over the other may depend on whether the massive technology companies benefiting from the artificial intelligence mania will continue to boost the more concentrated S&P.
Risk is the bane of good performance and we should expect to see the greater success of our S&P proxy to translate into higher volatility. But, alas, this was not the case. It had a smaller loss in turbulent 2022 (-18.1% to -19.5%) and a less severe drop at the extreme (-23.9%) than its all-market counterpart (-24.9%).
The Vanguard S&P’s consistency has been nothing short of remarkable. It outgained 90% of its mostly actively managed peers, slipping under the 60th percentile only during the debacle of 2022, when it hovered around fifty-fifty. By comparison, Vanguard’s all-market vehicle underperformed the average large blend fund twice, including at the 25th percentile in 2022. The inability of active management to beat the passively invested Vanguard S&P 500 ETF more than 10% of the time over ten years is reprehensible, but a tale oft told.
What do we know and what do we not know? Well, we’ve seen how a small difference in performance between two very similar funds can snowball into a meaningful divergence in profits. We’ve also turned up something anomalous—the better-performing S&P 500 ETF was actually less volatile than Vanguard’s total stock market ETF.
What we don’t know begins with the finding itself, which may or may not be repeated. Clearly, the S&P benefited from two tailwinds—the dominance of giant, mostly technology and other growth stocks and the weakness of small caps. None of us know whether the comparative outperformance of the S&P will endure or earn a place in the graveyard of most other market misbehavior. Curiously, to believe that the trend is durable is to lend some credence to momentum thinking. Alternatively, imagining a shift from the higher-performing Vanguard 500 to the lagging Vanguard Total Market has a whiff of rebalancing. VOO and VTI are indeed close brothers, but they are not identical twins.
The implications here for retirement are not immediately clear. The different ways the S&P and total stock market fund were constructed should make for a substantial difference in performance, but that is not the case. The modest difference now where the honors go to the S&P can easily be reversed years hence if artificial intelligence turns out to be less than a revolution and smaller companies regain their gusto.
Despite lagging some in recent years, Vanguard’s more comprehensive market fund is more diversified by sector and size than its S&P. This feature is unlikely to change since the total stock fund mandates it while the S&P by definition restricts it. For my retirement money, I would prefer the total stock market fund.
Even so, unless you have stable and sufficient retirement resources available otherwise, a very large allocation to either fund is probably not advisable nearing or early in retirement. An unlucky sequence of returns will rob you of the assets needed to fully participate in the market’s inevitable recovery and wreak havoc on your withdrawal strategy and emotional well-being. Fortunately, several methods offer protection from this hardship, including high quality short-term bonds. You don’t want to surrender the reward for all those years of hard work and methodical contributions.
