Most long-term investors need equity exposure. However, when you
make the most basic allocation decision within U.S.
equitiesâbetween large-, mid- and small-capâyouâre
effectively making a market call.
After all, you probably wouldnât 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
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
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
Whatâif anythingâdifferentiates total-market funds?
Performance, it turns out.
Letâs look at three of the largest funds by assets, each of
which has more than 10 years of history. Hereâs a graph showing
total return since May 2001, the most recent inception date of the
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.
So even in this most vanilla of vanilla ETF segments, your
choice of funds mattersâa lot, in fact. Over roughly 10 years,
youâre looking at a difference of about 9.5 percentage
The expense ratio for each ETFâthe direct cost of owning the
fund, in this case compounded over 10 yearsâhelps 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.
Itâs 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.
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 Iâd guess the true number is lower today than at the
end of the second quarter. (Augustâs cruel returns likely drove
the numerator down.)
VTI has a smaller dividend yield too, but this measure has price
in the denominator, so itâs 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, VTIâs not the only low-cost
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. Itâs 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. Hereâs
how it stacks up against the other three funds since its
SCHB eked out the top spot for the period. Its 10.22 percent
return edged VTIâs 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 thereâs more:The Focus Morningstar U.S. Market
(NYSEArca:FMU) offers the lowest expense ratio in the segment, at
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 thatâs 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. Theyâre liquid, so youâre not likely to get hurt trading
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 loserâs game, and that youâre at least as likely to guess
wrong as guess right, then the big bucket has your name on it.
Don't forget to check IndexUniverse.com's ETF Data
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