Buying a Better Index Than the S&P 500

by Will Ashworth | August 27, 2014 6:30 am

Warren Buffett suggests most investors buy a low-cost S&P 500 index fund[1]. In the eyes of the Oracle, the S&P 500 is the perfect index. He particularly likes the Vanguard S&P 500 ETF (VOO[2]), but I suspect both the SPY and IVV would do just fine for most investors.

But is it really?

The S&P 500 index represents 500 of the largest publicly traded companies [3]in the U.S. by market capitalization. The total market cap of the 501 holdings is $18.2 trillion with a median market cap of $18 billion. (The Google [GOOG][4] split created an additional holding, but there remain only 500 companies.) Covering 80% of the U.S. equities market, many consider it the best gauge of large-cap stocks.

For some, blue-chip means the same thing as large-cap, and you don’t get any bluer than the S&P 500. The only problem with this rationale is that large caps lose money from time to time just like midcaps, etc. In the 2008 collapse, the S&P 500 lost 37%. If you held either the SPY[5] or IVV[6] (the VOO didn’t exist until September 2010[7]) and nothing else, you would have lost more than one-third of the value of your portfolio. That’s tough sledding even for the most experienced investor.

The big question is: Could you have done any better?

The blunt answer is: Yes, you could have.

We’re Gonna Need a Bigger Index

The S&P 500 is part of the bigger S&P 1500, which also includes the S&P SmallCap 600 and the S&P MidCap 400. The S&P 1500 also lost 37% in 2008. However, the S&P SmallCap 600 lost just 31%. Unfortunately, the iShares Core S&P Total US Stock Market ETF (ITOT[8]), which tracks the S&P 1500, has just 5% dedicated to small-cap stocks[9].

So, if someone was willing to undertake greater risk[10] by investing their entire portfolio in the iShares Core S&P Small-Cap ETF (IJR[11]), which tracks[12] the small-cap index, they could have reduced their 2008 loss by six percentage points or so.

That’s great for someone who has absolutely no fear of risk. But most of us need something that ratchets down the fright factor, something that takes the S&P 500 or the S&P 1500 and goes one better.

For me that vehicle is the CRSP US Total Market Index, which tracks a total of 3,699 U.S. companies ranging in market cap[13] from $3 million all the way up to Apple (AAPL[14]) at $560 billion. The index gives you nearly 100% of the U.S. investable equity market — 10 and 20 percentage points more than the S&P 1500 and S&P 500 respectively. While that might not seem like a lot, over the long-term it could mean the difference between a beach vacation and a luxurious trip to Italy.

How so?

Ten years ago, if you invested $100,000 in the Vanguard Total Stock Market ETF (VTI[15]), which tracks the CRSP US Total Market Index, today you’d have $237,000. The same investment in the IVV would be worth $222,000 while the ITOT would deliver $225,000. By adding an extra 10 percentage points of U.S. equity exposure you gained an additional $12,000-$15,000 in total market value, which would pay for a two-week stay[16] in a beautiful villa for you and your family.

And what does it cost you? Well, nothing in terms of fees and taxes.

Both the VOO and VTI charge an annual expense ratio of 0.05%. In terms of taxes, the tax-cost ratio over the past three years of the VTI is 0.51%[17], two basis points less than the VOO[18], which means you keep more after tax by owning the VTI.

However, the big difference is the market cap composition of the two ETFs. The VOO has just 12%[19] invested in stocks with market caps less than $10 billion while the VTI puts 28%[20] of its portfolio toward market caps of $10 billion or less. As a result, Morningstar gives VOO[21] a risk rating of “below average” compared to “average” for the VTI[22].

Is below-average risk as worth $12,000 more than average risk? I don’t think so.

So, for anyone who’s looking for a more complete index, the CRSP US Total Market Index is a better than the S&P 500.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2014/08/better-index-sp-500/

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