Ferri: You Can Do Better Than The S&P 500

September 04, 2014

The S&P 500 is perfectly fine, but index investors can choose a better fund.

I’m an index fund investor, but I don’t invest in S&P 500 index funds. It’s not the type of index I want in my portfolio, unless I’m in a pinch. Here’s why.

The S&P 500 is arguably the most important stock market index on the planet. It represents the free-float value of 500 major corporations primarily domiciled in the US and gives investors an idea of the overall movement in the US equity market. The index is computed by using weighted market capitalization and it is continually updated throughout the trading day.

The S&P 500 has the distinction of being the first index to be tracked by a publicly available index fund. The Vanguard 500 Index Fund (ticker: VFINX) began operations on August 31, 1976. Investors only entrusted $11 million to the fund during the initial offering, according to John Bogle, Vanguard’s founder. VFINX became the largest US equity mutual fund in existence at one point in the late 1990s.

In 1994, the first commercially successful exchange-traded fund (ETF) was launched in the US. It also tracked the S&P 500. Today, the SPDR S&P 500 ETF Trust (ticker: SPY) is the largest ETF traded on the market by assets.

There is over $5 trillion benchmarked to the S&P 500 index in some form including derivatives, according to the company website, with direct index assets approaching $2 trillion, according to an interview I did with David Blitzer, managing director and chairman of the S&P Dow Jones Index Committee. He has the overall responsibility for index security selection in the S&P 500 and many other indexes at S&P Dow Jones.

With so much money tracking the S&P 500 index, why would I choose not to invest in it? It’s not that I believe the index is flawed; to the contrary, the S&P 500 is a fine benchmark and the companies in the index are probably the most liquid in the world.

The reason I’m not an S&P 500 investor is because my goal is different from S&P. They’re trying to capture the return of large leading industries in the US economy; I’m trying to capture the return of the US stock market. There is a slight difference.

The 500 constituents that make up the index represented about 80 percent of the US equity market by capitalization, according to S&P. In contrast, the total US stock market includes nearly 4,000 stocks, according to the Center for Research in Securities Prices, better known as CRSP. Since I’m trying to capture the return of all stocks, I prefer a total stock market index fund over one that tracks the S&P 500.


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