Extended market index fund

An extended market index, or completion index, fund is combined with an S&P 500 fund such that the total "completes" the composition of the US total stock market.

A completion index is formally defined as a sub-index of a Total U.S. Market Index which excludes the constituent stocks of the S&P 500 stock index.

Extended market index funds contain small-cap and mid-cap companies, but not large-cap companies listed in the S&P 500 Index. These funds are designed for investors already using S&P index funds. Vanguard offers an [ Vanguard Extended Market Index Fund] (VEXMX for investor shares, VEXAX for Admiral shares, VXF for the ETF). Other companies offer similar "extended market index" or "completion index" funds. These funds hold all, or most, of the stocks not included in the S&P 500 index.



How to use an extended market fund
Vanguard's product summary says, in part:
 * The fund is considered a complement to Vanguard 500 Index Fund. Together they provide exposure to the entire U.S. equity market.

Primarily, then, these funds should be used by investors who want to invest in the total market, and would like to use a total stock market fund, but who, for whatever reason, find it necessary to hold a separate S&P 500 index fund. There is no well-known investment theory that ascribes any particular virtue to "the total market except for the S&P 500" as an entity in itself. Investors who want to depart from total market weighting and choose their own proportion of large-cap stocks, probably want to adjust mid-cap and small-cap exposure independently too.

The obvious reason why an investor would want the "Total Market with the S&P 500 stocks removed" is that the investor already holds an S&P 500 index fund. An investor might be constrained by limited choices in a 401(k) plan, or by existing holdings of an S&P 500 fund in a taxable account that can't be exchanged without adverse tax consequences. Obviously, any investor who is not constrained to hold an S&P 500 index fund can simply invest in a Total Stock Market index fund.

Investors desiring to duplicate the total market portfolio using an extended market fund should manage their portfolio so as to include the S&P 500 fund and an Extended Market Index fund in about an 80%/20% proportion, and they will then be essentially holding the market.

The 80%/20% ratio may require rebalancing from time to time, and the ratio may change with the composition of the total market. This does not need to be done frequently or with scrupulous accuracy. One convenient source for the proper current percentage composition is Vanguard's benchmark comparison.

Overlap and other niceties

 * Vanguard's Extended Market Index Fund tracks the Standard & Poor's Completion Index, which is the S&P Total Stock Market Index with the S&P 500 stocks removed. So, if you add them back in the proper proportion (and rebalance as needed), the mix tracks S&P Total Stock Market Index. Vanguard Total Stock Market Index Fund tracks a different index provider's Total Market index, the CRSP US Total Market Index, so in theory the results are not identical.


 * Most or all "completion indexes" complete the S&P 500. So, there is no overlap, no duplicated stocks in any mix of an S&P 500 fund and a completion index fund.


 * The S&P 500 is mostly large-cap and often thought of as large-cap, but it is not a pure large-cap index. Therefore, a completion index is not a pure combination of mid- and small-caps. Furthermore, different index providers divide the market between between large, mid, and small in different ways. Thus, for example, if an investor mixes funds based on different index provider's indexes, there can be significant overlap between these providers' large cap index funds and an S&P completion fund.


 * These are theoretical issues. The differences involved are small, and probably of concern only to purists.


 * The extended market index is overweight in mid-cap growth. This probably isn't important, but it does underline the fact that the extended market index is not the most suitable choice for fine control of "style box" weights in an overall portfolio.

Mid-cap growth overweight
The S&P 500 is S&P's choice of "leading companies in leading industries." In 1957 when the index was developed, it was intended to represent, one could say, the whole market as seen by "normal" investors. Conventional wisdom at the time was that, in the language used by Benjamin Graham, "defensive investors" should limit themselves to "primary companies" in an industry. It wasn't until the eighties that the conventional wisdom began to advocate small-caps, and not until the nineties that people began to think of value and growth as numerically defined categories whose weight should be consciously chosen. The S&P 500's mid-cap holdings include an underweight to mid-cap growth that easily escapes notice because it's a small imbalance within the mid-caps which comprise only 13% of the S&P 500.

Morningstar's "holding style" chart for VEXMX follows. Notice 11/13/21 imbalance.

The corresponding chart for the Vanguard 500 Index fund, which tracks the S&P 500, shows the deficit in mid-cap growth, 5/5/3.

Dissenting views, and constrained choices in employer provided plans
Is an extended market index fund an appropriate tool for implementing a "small-cap tilt?"

The natural way to implement a "slice-and-dice" portfolio (dividing total stock market allocations into segments) is to use mutual funds that focus on and isolate the style factors; that is, funds that concentrate on one of the nine Morningstar style boxes. With regard to size alone, it seems illogical to use a fund that covers mid-cap and small-cap stocks.

While index funds targeted to particular style boxes might be better in theory, employer provided retirement plans frequently limit choices to actively managed funds with high expense ratios. An investor who desires to depart from market cap weighting with regard to size alone, and is limited by plan choices, may find that a low cost extended market index fund is the lowest cost way to implement the strategy.

Oftentimes, when the actual behavior of real-world small-cap and mid-cap funds are examined, surprises emerge. For example: Over a 10 year period (2002-2012), the growth charts for the Vanguard Small-Cap Index Fund (NAESX), Mid-Cap Index Fund (VIMVX), and Extended Market Fund are almost superimposed--it hardly seems to matter which is used.

A number of forum members feel that, regardless of theory, and regardless of the rationale behind the construction of a completion index; as a practical matter an extended market index fund can be a perfectly good way to provide a degree of small-cap tilt.