Unpacking ETFs: Total Market vs SP 500 - Which One Reigns Supreme?

Choosing the right ETF can be a daunting task, especially when you are looking at options like the Total Market ETF (like VTI from Vanguard) and the SP 500 ETF (like VOO from Vanguard). Both aim to offer different exposures, and the choice largely depends on your investment horizon, risk tolerance, and long-term goals. Let's dive into the differences and understand which one might be better for you.

What are Total Market ETFs and SP 500 ETFs?

Total Market ETFs like Vanguard's VTI are designed to track the performance of the entire US stock market. This ETF holds a broad selection of 3,721 of the largest stocks, representing the top 8,000 stocks in the US. By holding these larger companies, the total market ETF aims to capture the overall return of the stock market, minus some fees.

SP 500 ETFs like Vanguard's VOO, on the other hand, track the SP 500 index. This index is a subset of the larger US stock market, representing the 500 largest publicly traded companies. The SP 500 is often seen as a benchmark for the overall health of the US economy, and hence, the ETF based on it is a popular choice among investors.

When to Pick the SP 500?

If you believe that big companies will perform better than small companies, the SP 500 ETF is the better choice. Historically, large-cap companies have tended to outperform small-cap companies over the long term. However, SP 500 ETFs have lower fees because they are more popular, which can contribute to better overall performance.

When to Pick the Total Market?

If you are unsure which companies will outperform, or if you want a more diversified portfolio that tracks the entire market, the Total Market ETF is the way to go. By including smaller and mid-cap companies, the total market ETF can offer more diversification, potentially reducing risk and providing a more balanced exposure to the market.

Return and Risk Comparisons

The similarity in returns between the SP 500 and the MSCI US indices, which covers 99% of the total market value, is surprising. In fact, a close look at their performance charts reveals that the SP 500 (Orange line) has a blue shadow behind it from the MSCI US index (Blue line). This is because both indices are market-weighted, meaning larger companies have a bigger impact on the overall index returns.

Despite the slight differences in risk and return, choosing one over the other might not make a significant difference. However, if you're looking for the best expected return, the total market ETF is a slightly better choice, though not by a wide margin. The reason lies in the fact that smaller companies can offer more volatility and, potentially, higher returns.

Options Trading vs Regular ETFs

For those interested in trading options, ETFs like QQQ might be preferable. QQQ is an ETF that tracks the Nasdaq-100 index, which is dominated by technology companies. QQQ offers a small bid/ask spread and is easier to trade than many individual stocks and indexes. However, for the average investor, the choice between a Total Market ETF and an SP 500 ETF often hinges on fees, risk, and trust in long-term market trends.

Our backtest shows that while the total market ETF returns are slightly higher, the difference is minimal. Both the SP 500 ETF and the total market ETF offer nearly identical returns over the long term, making the choice slightly more about fees and risk tolerance.

Key Takeaways:

Total Market ETFs (like VTI) offer broader exposure to the US stock market, including smaller and mid-cap companies. SP 500 ETFs (like VOO) focus on the largest publicly traded companies, which are often seen as more stable and less volatile. For better expected returns, a Total Market ETF is preferable due to its exposure to a wider range of companies. Factors like fees and risk tolerance should also be considered when making your choice.

Good luck in your investment journey, and remember that diversification is key to managing risk and achieving long-term growth.