Choosing the right index fund

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PFgal
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Choosing the right index fund

Post by PFgal » Wed Apr 17, 2013 3:17 pm

I'm finally wising up about investing. (I won't bother to mention what I did in the past since it's irrelevant here.) I like Jim's advice over at http://jlcollinsnh.wordpress.com/ to invest in just one big index fund that seems to cover a bit of everything. He uses VSTAX.

I just moved everything over to Vanguard and the funds became available for investing today. I was all excited to invest, and then I got stuck. I was looking at VTSAX and VOO. They have the same fees but VOO returns a higher dividend. VOO is basically the S&P 500 while, as far as I can tell, VTSAX is that plus a lot more. I’d love opinions on how to choose one over the other. Or maybe there’s a third choice I should be considering? I'm new to this and I'd love any advice you guys can offer. I'm sure I'm not the only one trying to figure this out!

Thanks for any advice you can give!

-- My plan is to buy now and hold it for a long time (20 years? 50 years?)
-- Some will be in a Roth IRA and some in a taxable account. I can choose different investments for each account, of course.
-- As a side note, I also plan to invest a much smaller amount in a REIT like VGSLX. I'm open to advice there too, but that isn't my main concern at the moment.

Info about the two funds is here:

https://personal.vanguard.com/us/funds/ ... =INT#tab=4

https://personal.vanguard.com/us/funds/ ... =INT#tab=4

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nisiprius
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Re: Choosing the right index fund

Post by nisiprius » Wed Apr 17, 2013 4:40 pm

VTSAX. But the big thing is: it doesn't matter much. That's much more important than my reasons for preferring "VTSAX" over VOO.

Let me start with a shortcut. Vanguard has a web page about what they call their core funds. Take a look at that page. There are four, just four. One of them is VTSMX (which is the same fund as VTSAX, just a different share class). Notice that the fund they've picked to be a core fund is Total Stock (regardless of whether the symbol is VTSMX or VTSAX or VTI).

Notice that they do NOT include any S&P 500 fund as one of their "core funds."

To begin with, an annoying detail, the two funds you mention each come in what I'll call three "packages." Think of them as small cans, big cans, and bottles. Same stuff inside. You open them in different ways, they might have slightly different unit prices, some think the cans and bottles taste slightly different. After listing them, I'm going to ignore the three flavors and just talk about the two indexes--the "right index" as you say.

A total stock market index:
Mutual fund, $3,000 minimum investment, VTSMX ("Investor shares")
Mutual fund, $10,000 minimum investment, VTSAX ("Admiral shares")
ETF, 1-share minimum I think, VTI

S&P 500 index:
Mutual fund, $3,000 minimum investment, VFINX ("Investor shares")
Mutual fund, $10,000 minimum investment, VFIAX ("Admiral shares")
ETF, 1-share minimum I think, VOO

My favorite tool for comparing the past behavior, not just performance but past behavior, is growth charts, which you can find on the Vanguard website, under the "performance" tab for the fund (where you compare it with other Vanguard funds) for up to 10 years back; or, better, Morningstar growth charts, which are explained here.

The original S&P index goes back to 1923 and included 90 stocks. In 1957, they added a new one which included 500 stocks, which soon displaced the old one. These were early attempts to index "the market" scientifically, and, unlike the Dow, are capitalization-weighted. For many years, the S&P 500 was thought of as being "the market" or close enough as makes no difference, and it is still a pretty good proxy for the whole market. The 500 stocks in it are mostly large companies, but they aren't selected strictly by size, but by a committee process of picking "leading companies in leading industries," whatever that means.

OK, so, the S&P 500. The classic "market index."

Now in 1980 a researcher named Ralph Banz discovered that the stocks of smaller companies seemed to have higher returns than the market as a whole. This turns out not to be as cut-and-dried as all that, and mostly the higher returns are just reward because these are riskier companies, but anyway that sparked interest for "small-cap" stocks, and people started to think that if they did want to look at the total market, they should have an index that includes the smaller companies, too, and by then there were computers and it was easier to do. The original total market index was called the Wilshire 5000.

Here's the thing. The stocks of the S&P 500 make up 80% of the total stock market, by capitalization. And while small-cap stocks behave a little differently from the total market, they are still stocks and they soar when the market is soaring and crash when the market is crashing, so while people make a big thing about it, it actually makes surprisingly little difference whether you put them in or leave them out. Here's the growth chart, and, just for laughs, I am going to add a third fund. I'm using Investor shares because the record goes back further, but it would look exactly the same if I used VTSAX and VOO, trust me. Blue is Total Stock, orange is S&P 500. Here are those two. They are different and you can make much of it if you like, but they aren't terribly different. Don't focus on better/worse, focus on same/different.
Image
Now let's throw in a third fund.
Image
You see the point? The green fund is really different from the other two. The green fund happens to be an international fund--I used this one because Vanguard's doesn't go back far enough. The difference between the international fund and the two domestic index funds is much bigger than the difference between the two domestic index funds.

Now, to get back to my reasons for preferring VTSAX. My reasons are this: if you are looking at an S&P 500 fund, usually the reason is that you want "the market." (If, for some reason, you wanted to focus on large-caps, you probably wouldn't want the S&P 500 because it isn't a systematic screening of large caps. You'd probably want something like the Vanguard Large-Cap Index Fund, which is). And if you want "the market," the Total Stock Market funds are a more faithful, more complete implementation of that goal than an S&P 500 fund--although an S&P 500 fund is still close.
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Jake
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Re: Choosing the right index fund

Post by Jake » Thu Apr 18, 2013 9:42 am

As I lurk around and occasionally post a question I am constantly amazed at the quality of responses and the generosity of intelligent folks who post here.
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Bogle101
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Re: Choosing the right index fund

Post by Bogle101 » Thu Apr 18, 2013 10:27 am

Wow cannot get a better answer than the post from nisiprius on such a basic question.

I would recommend the total stock over the s&p 500 index, just because you get some exposure to mid and small caps as well. But by now you must know that the two funds are quite similar.

Since you seem to want to only invest in just one fund, I would also recommend you look at Vanguard's Total World Stock Index (VTWSX). It will give you some international flavor as well.
25% S&P 500 | 25% Extended Market | 20% International | 10% REIT | 10% Sector Funds | 10% Cash

PFgal
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Re: Choosing the right index fund

Post by PFgal » Thu Apr 18, 2013 2:57 pm

nisiprius thank you so much for such a detailed, thoughtful answer! You answered all of my questions and made excellent points. Everyone else I'd asked kept pointing out that one was S&P 500 and the other was a total market index fund, but no one ever explained the difference. Thanks largely to your excellent explanation, I just invested in VTSAX with great confidence. Thanks so much!

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dratkinson
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Re: Choosing the right index fund

Post by dratkinson » Thu Apr 18, 2013 3:47 pm

PFgal,

You don't say, so I'm not sure how deep is your new-found knowledge of investing. (You don't want to be the blind led by the blind.)

Before you bail off too deeply, ensure you have read, understand, and accept the information on this site and in the recommended books. If you have not already done so, begin your understanding by reading here:
After you understand more, you will be able to answer most questions for yourself. And the advice you receive here will tweak your understanding, not be a replace for your lack of it.



The advice you have received so far is correct. But you must have the background knowledge to understand why it is correct, and how it fits into the larger picture of your total investing goals and planing.

With understanding, you will be able to say during a market downturn, "...I knew this was coming and I know how to make the best use of it."

Without understanding, you will can only say, "...someone on a website told me to do it and now it is coming undone. Oh, woe is me." No one whats this for you.



Welcome.
d.r.a, not dr.a. | I'm a novice investor, you are forewarned.

retiredjg
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Re: Choosing the right index fund

Post by retiredjg » Thu Apr 18, 2013 4:10 pm

Welcome to the forum!

You've picked a good fund, but one good fund does not make a good portfolio. At the very least, you need some fixed income assets such as a bond fund. And most folks, but not all, add in a stock fund from foreign countries.


I think you might find this Wiki page helpful. Wiki article link: Three-fund portfolio

Here's a place for Getting Started

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Taylor Larimore
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The Three Fund Portfolio

Post by Taylor Larimore » Thu Apr 18, 2013 4:15 pm

PFgal:

Welcome to the Bogleheads Forum!

Take a look at the Three Fund Portfolio which contains Total Stock Market Index Fund but also Total International and Total Bond index funds for better diversification resulting in less risk.

The Three Fund Portfolio

Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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