Many investors and advisers alike believe that the best way to capture market returns is to invest in a Total Stock Market Index Fund. This is true to a degree but there are advantages and disadvantages to this strategy.
The Basics on Total Stock Market Index Funds
You may already be familiar with S&P 500 Index Funds. Total Stock Market Index funds work in a similar way. They hold a basket of stocks that mirror a benchmark, which in this case is the Wilshire 5000 or the Russell 3000. Instead of holding stocks of 500 or so of the largest US domestic companies, Total Stock Market Index Funds will hold stocks of thousands of US domestic companies and will mirror the performance of the given benchmark.
The Advantages of Total Stock Market Index Funds
Like all index funds, the expense ratios are low because they are passively managed (no need for research or heavy management fees). Investors also get exposure to thousands of stocks so diversification is stronger than other kinds of mutual funds or exchange traded funds (ETF).
The Disadvantages of Total Stock Market Index Funds
There is no real disadvantage but rather an argument that an investor can receive the same benefits and results by using an S&P 500 Index fund. In fact, the performance of S&P 500 Index Funds and most Total Stock Market Index Funds are identical. This is because the top 500 holdings of a Total Stock Market Index Fund typically represents 75% of the overall portfolio weighting, with the other 25% representing the other 3,000 to 4,000 stocks. Also, some investors can be fooled into believing that they can simply place all of their investment assets into just one fund and be truly diversified.
A Greater Solution?
Whether you use an S&P 500 Index Fund or a Total Stock Market Index Fund in your portfolio, it is important that you apply the same portfolio building strategies: Buy several funds representing different mutual fund types that create an overall asset allocation that suits your investment objective.
Interesting article, a stock index fund can be a good way of getting the desired Beta exposure to a certain market with lower costs…
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