Why A Total Market ETF?

October 05, 2011

Stocks are cheap and, for those courageous enough to buy now, total-market funds could be the way to go.

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.

VTI/IWV/IYY: Total Return since May 2011

 

Wow. Since its inception on May 24, 2001, the Vanguard Total Stock Market fund (NYSEArca: VTI) has returned 17.11 percent compared with 10.8 percent and 11.2 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 6.3 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.

 

Total Market ETFs: Top 3 Economic Sectors

 

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