Total Stock Market Index vs. S&P 500 Index
The difference between a total stock market index fund and an S&P 500 index fund is that the S&P 500 Index includes only large-cap stocks. The total stock index includes small-, mid-, and large-cap stocks. However, both indexes represent only U.S. stocks.
Total Stock Market Index Fund Holdings
Funds that claim to be “total stock market” index funds typically track an index that includes between 3,000 and 5,000 small-, mid-, and large-cap U.S. stocks. Examples of total stock indexes include the Wilshire 5000 Index and the Russell 3000 index. The Vanguard Total Stock Market Index Fund (VTSAX) tracks the CRSP U.S. Total Stock Market Index, which includes approximately 4,136 stocks.
S&P 500 Index Fund Holdings
Unlike total stock market index funds, S&P 500 index funds only track specific stocks on the Standard & Poors 500 index. The S&P 500 consists of about 500 stocks of the largest U.S. publicly traded companies, as measured by market capitalization.
Total Stock Market Index vs. S&P 500 Index: Performance
Investors may be surprised to know that returns for total stock market index funds and S&P 500 index funds are similar. The conventional thinking is that small-cap stocks outperform large-cap stocks in the long term (periods of 10 years or more). This assumption suggests that a total stock market index fund would outperform an S&P 500 index fund over time. Compare the performance of some historical returns of a total stock market and S&P 500 indexes: Since these funds are cap-weighted, many holdings are large-cap stocks, making the performance similar to an S&P 500 index fund. A total stock market fund does not capture the total stock market; it captures a majority of the large-cap stock market with a small representation of other segments, such as mid-cap and small-cap stocks. Therefore, its average market cap is large-cap, explaining why it performs similarly to an S&P 500 index fund.
Bottom Line
Total stock market index funds are only slightly more diversified than S&P 500 index funds. Since both types of indexes are heavily weighted toward large-cap stocks, the performance of the two funds is highly correlated (similar). However, investors can achieve greater diversification, and potentially greater performance, by selecting their own allocations. For example, investors wanting to capture a complete representation of the U.S. stock market may choose to allocate approximately one-third of their portfolio assets to three separate indexes—the S&P 500 for large-caps, the S&P mid-cap 400 for mid-caps, and the Russell 2000 for small-caps. Most importantly, investors should first determine that stocks are appropriate for their risk tolerance and financial goals.
