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• Is Russell Next On ETF-Closure List?
• FocusShares To Promote ETFs—Finally
• Why A Total Market ETF?

• IWV 0% Rate It
• IYY 0% Rate It
• SCHB 0% Rate It
• VTI 0% Rate It

Most long-term investors need equity exposure. However, when you make the most basic allocation decision within U.S. equities—between large-, mid- and small-cap—you’re effectively making a market call.

After all, you probably wouldn’t bother to buy three funds instead of one unless you planned to deviate from a marketlike allocation of roughly 70 percent large-cap/20 percent midcap/10 percent small-cap.

But who dares to make market calls in these times, when the likes of Bill Gross and John Paulson get it wrong?

Total-market funds eliminate this decision. The idea of owning the whole market, advocated by investment pioneers from Harry Markowitz to John Bogle, represents index investing at its purest.

You get a well-diversified basket of stocks from largest to smallest, selected and weighted by the market value of equity. The allocation decision is effectively made by millions of participants. (To be clear, my focus here is on U.S. equities only.)

Choice Matters

What—if anything—differentiates total-market funds? Performance, it turns out.

Let’s look at three of the largest funds by assets, each of which has more than 10 years of history. Here’s a graph showing total return since May 2001, the most recent inception date of the three.

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Wow. Since its inception on May 24, 2001, the Vanguard Total Stock Market fund (NYSEArca:VTI) has returned 17.11 percent compared with 7.56 percent and 7.94 percent for the iShares Russell 3000 (NYSEArca:IWV) and the iShares Dow Jones U.S. (NYSEArca:IYY).

So even in this most vanilla of vanilla ETF segments, your choice of funds matters—a lot, in fact. Over roughly 10 years, you’re looking at a difference of about 9.5 percentage points.

The expense ratio for each ETF—the direct cost of owning the fund, in this case compounded over 10 years—helps to drive this difference. VTI currently charges 0.07 percent, compared with 0.20 percent for both IWV and IYY.

We can peek at the holdings for some sense of how the funds compare going forward. Before we do, note this caveat:The VTI info is stale. It’s based on data from June 30, 2011, not Sept. 30. Like most Vanguard funds, VTI releases data quarterly, with a lag, and not daily like most ETFs.

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Sectorwise, VTI leans a bit toward the financials, with 15.4 percent compared with 13.9 percent for IYY. Compared with its competitors, VTI also underweights consumer noncyclicals a bit. This sector-weight combo might produce more volatility for VTI in the short run.

Regarding fundamentals, Vanguard shows a higher price/earnings ratio, but I’d guess the true number is lower today than at the end of the second quarter. (August’s cruel returns likely drove the numerator down.)

VTI has a smaller dividend yield too, but this measure has price in the denominator, so it’s probably understated.

The concentration in top 10 holdings and average market cap hint that IYY leans toward blue chips compared with VTI and IWV. If this holds, IYY may have a smoother ride in the short run than the other two, but possibly lag a bit over the very long haul.

Other Low-Cost Options

For the price conscious, VTI’s not the only low-cost option.

The Schwab U.S. Broad Market (NYSEArca:SCHB) undercuts VTI by a basis point with its 0.06 percent expense ratio. SCHB has gathered significant assets since its Nov. 3, 2009 launch. It’s now the third-largest fund in the segment, so trading in and out of it should be no problem.

SCHB has almost two years of performance data by now. Here’s how it stacks up against the other three funds since its rollout.

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SCHB eked out the top spot for the period. Its 10.22 percent return edged VTI’s 10.12 percent. IYY and IWV trail at 9.56 percent and 9.46 percent, respectively, for the period. SCHB likely has its own subtle tilts just as the other three funds do.

But there’s more:The Focus Morningstar U.S. Market (NYSEArca:FMU) offers the lowest expense ratio in the segment, at 0.05 percent.

So far, FMU has failed to attract significant assets since its March 30 launch. (I excluded it from the chart above due to its brief performance history.) FMU trades relatively thinly, so use a limit order to transact if that’s the fund you go with.

Totaling It Up

At the end of the day, one total market fund is easier to manage than three separate large-, mid- and small-cap funds. The time and expense to rebalance is eliminated.

Total market funds handle that chore inside the fund automatically and efficiently. Most importantly, they deliver a marketlike allocation between the three size baskets.

Funds like VTI and SCHB deliver the total market at very low cost. They’re liquid, so you’re not likely to get hurt trading them.

Why not apply the same logic to the whole market that you rely on within each size bucket? If you buy the notion that investing is a loser’s game, and that you’re at least as likely to guess wrong as guess right, then the big bucket has your name on it.

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