VTSAX vs VFIAX
Vanguard Total Stock Market Index Fund, the VTSAX and Vanguard 500 Index Fund, VFIAX are by no doubt the two biggest and most popular index funds in the world. With over a trillion dollars and $700 billion dollars in assets under management respectively, they are a force to be reckoned with in the investing world.
But one of the most common questions many of us ask is, if we had to choose one, which one would it be? Which one is the best, if we can even make that decision? In this post we are going to deep dive into two of the most popular index funds in the market. The VTSAX and the VFIAX, and see which one might be the best for you. A spoiler alert, I prefer the total stock market index fund.
VTSAX 101
Let me give you a brief overview of Vanguard Total Stock Market Index Fund, also better known as the VTSAX.
Index - VTSAX tracks the CRSP US Total Market Index, which aims to replicate the entire U.S. total stock market, including large-cap, mid-cap, small-cap, and micro-cap stocks.
Composition - It represents approximately 4,000 (4,066) US based companies. The top holdings in this fund are Apple, Microsoft and Amazon. Not a surprise given these are currently the biggest companies in the US.
Expense Ratio - It has an expense ratio of 0.04%. Which means if you have $10,000 invested in Vanguard Total Stock Market Index Fund, you are essentially paying $4.00 for Vanguard to manage this fund for you.
Minimum - In addition it has a minimum investment of $3,000.
ETF Equivalent - If you don’t have $3,000 to invest, an ETF is a good option to kick off your investing journey. The ETF equivalent of VTSAX is VTI, Vanguard Total Stock Market ETF and it has an expense ratio of 0.03%. You can even convert your VTI over to VTSAX once you reach the minimum level of $3,000
Performance - Its average annual total returns in the past 10 years has been 12.40%. To put this in perspective with annual compounding, if you had put in $10,000 10 years ago into VTSAX, it would have grown to approximately $32,000 today (32,185). Not bad for buying and holding.
VFAIX 101
Now, let’s review the Vanguard 500 Index Fund. Vanguard and the industry’s original index fund created in 1976. The VFIAX is the latest version updated in the year 2000.
Index - VFIAX seeks to track the investment performance of the Standard & Poor’s 500 Index, an unmanaged benchmark representing U.S. large-cap stocks. More specifically 500 largest companies in the United States.
Composition - It represents 505 US based companies. The top holdings in this fund are Apple, Microsoft and Amazon. Pretty much identical to the VTSAX.
Expense Ratio - Same as VTSAX, it has an expense ratio of 0.04%.
Minimum - Same minimum investment of $3,000.
ETF Equivalent - Again, if you don’t have $3,000 to invest, an ETF is a good option to kick off your investing journey. The ETF equivalent of VFIAX is VOO, Vanguard S&P 500 ETF which also has an expense ratio of 0.03%.
Performance - Vanguard 500 Index Fund’s average annual total returns in the past 10 years has been 12.75%. To put this in perspective with annual compounding, if you had put in $10,000 10 years ago into VFIAX, it would have grown to approximately $33,000 today (33,202). Slightly more than VTSAX given the higher returns.
With the mechanics out of the way, let me talk about two personal reasons why I prefer the VTSAX versus the VFIAX. And I want to emphasize the personal part. Both are excellent funds and you honestly can’t go wrong with either. I just personally like VTSAX so let me share with you why.
Composition
The biggest notable difference between these two funds as you can guess is in the composition. As I mentioned earlier, the Vanguard Total Stock Market Index Fund encompasses a wider universe of stocks than does the Vanguard 500 Index Fund; 4,000 in VTSAX versus 500 in VFIAX.
But that’s not the primary reason I prefer VTSAX because in the big picture the difference is actually not as great as it might seem. The 500 stocks in the Vanguard 500 Index Fund make up about 80% of the total US equity market capitalization, so there is significant overlap between VTSAX and VFIAX. With that said, the approximate 20% of the market capitalization that is found only in the total stock market index fund does provide greater diversification because of the presence of smaller stocks.
And historically, there have been times when small-cap stocks have outperformed large-cap stocks; most often during times of high inflation. However, we must be careful not to try to predict the timing on these because if market history tells us anything, no one can predict the future. Benjamin Graham, one of the most famous investors has said:
"If I have noticed anything over these sixty years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market." - Benjamin Graham
But despite the similarities, a key factor that makes me favor the VTSAX over the VFIAX is this; the fact that the S&P 500 is not a purely cap-determined index. Though the on-going recycling of new and old companies within the S&P 500 index is most likely automated with a computer program, the initial criteria for what companies are included and excluded are set by real live human beings.
A committee of economists and analysts at Standard & Poor's maintains the index and may exclude companies for a variety of reasons, including that a company is no longer considered financially viable as a result of ongoing losses, that the company's stock is not liquid enough, or because the stock throws off the index's sector balance.
The case of Tesla helps to illustrate the impact of the index company selection process. Currently Tesla is easily included as one of the 10 largest companies in the United States with a market capitalization of close to $600 billion dollars. So it is easy to assume that Tesla has always been a component of all large cap U.S. stock indexes like the S&P 500. However, would you be surprised to know that Tesla wasn’t added to the S&P 500 until Dec 2020?
Yes, Tesla was a much smaller company several years ago, but as of January 2013, Tesla’s market capitalization was still around $4.3 billion, above the minimum market capitalization requirement of $4 billion for the S&P 500 at the time. But it didn’t meet the profitability criteria set by the committee. Therefore it wasn’t added to the index until Dec of 2020, 10 years after it went public.
On the other hand, Tesla was added to the CRSP US Total Market Index in June 2010. Immediately after it went public. And the CRSP US Total Market Index is the index that VTSAX tracks. Unlike the S&P 500, the CRSP indexes do not have a profitability requirement for new additions to the index. The CRSP U.S. Total Market Index, tracks pretty much all publicly available equities that meet minimum liquidity requirements, and therefore equates to roughly 4,000 companies.
I do want to clarify that this isn’t to say S&P 500 index is a worse index than the total market index. Because as I mentioned earlier the impact difference between the two are quite minimal, especially when we compare their returns as we will do in the next section. But emotionally I can’t help myself but feel more secure with the idea of holding a fund that tracks a broader index like the total market and includes more than 4000+ companies.
Performance
Alright, with that said, let’s take a look at the specific returns between these two funds to see if we can discern any performance difference. Do you want the short answer? Not that much.
When we compare the past 3-year difference in performance, VFIAX has higher returns at 10.18% versus VTSAX’s 9.67%. The variance tightens a bit when we go back 10 years. VFIAX returned 12.75% versus VTSAX’s 12.40%. But when we go back more than 20 years. All the way back to the year 2000, VTSAX outperforms VFIAX. 7.25% versus 6.93%.
3-Year Variance: VFIAX (10.18%) vs VTSAX (9.67%)
10-Year Variance: VFIAX (12.75%) vs VTSAX (12.40%)
22-Year Variance: VFIAX (6.93%) vs VTSAX (7.25%)
Why the variation in returns with time? Take a look at the following Callan Periodic Table of Investment Returns. This chart graphically depicts annual returns for various asset classes, ranked from best to worst going back to 2007. It ranks from top to bottom, which asset classes performed best at each respective year.
The Callan Periodic Table of Investment Returns
Can you discern any trend here? Probably not. You see times when large equity caps did well. You see times when small cap equity did well. And you even see times when real estate did well. What this table highlights is the inconsistency in the performance of different asset classes each year. Just because the large cap equity fund did well in one year doesn’t guarantee that it will continue to perform better than other asset classes the following year.
And this is reflected in the performance of VFIAX and VTSAX that we saw earlier. When small cap stocks outperform large cap stocks, VTSAX saw a slight edge. However when large cap outperform small cap, VFIAX performed slightly better. To know when this will happen is akin to trusting a fortune teller. Warren Buffet said himself:
"We've long felt that the only value of stock forecasters is to make fortune tellers look good." Warren Buffett.
And the correlation between these two funds is amazingly high. Especially when we wind the clock back more and more. The long-term correlation between the S&P 500 and the total stock market index is 0.99. 1 is perfect correlation. What this means for me is that trying to make my decision based on past performance is a foolish effort. We don’t know what the future holds. There is no way we will ever know when VTSAX will outperform VFIAX again or vice versa.
Because when we try to predict the future, we are admitting to the fact that we want to market time and are looking to dance in and out of the market based on perceived trends. The only trend I am aware of is the strength of the American economy and the American companies as a whole in the long run. Therefore when I have a choice, I do prefer the broader market index and therefore VTSAX because it eliminates my inclination to look at the difference between large cap and small cap companies.
Many hardcore advocates of VFIAX argue that its simple to supplement the large cap heavy VFIAX fund with small cap and mid cap funds like the Vanguard’s small-cap index (VSMAX) and mid-cap index (VIMAX). You get the added benefit of small and mid cap companies as well as the flexibility to control the allocation.
However, my thought is this: why add more complexity to your portfolio when it might not make that much of a difference in the long run? With more funds I need more accounts and also need to spend more time thinking about the right allocation between all these sub categories.
I don't want to give myself room to second guess myself - because knowing me if I had a choice, I know I would spend way too much time trying to optimize my large cap, mid cap to small cap ratios. And at the end without much to show for it. I think simplicity is one of the most underrated concepts in life, therefore I choose VTSAX because it owns all of them and it makes my life super simple.
Conclusion
With that said, again in the big picture of things, both VTSAX and VFIAX are excellent funds. And when I mean really excellent, the best of the best. You cannot go wrong with either of them. If we were to spend any more time on this to argue which one is better than the other, we are really splitting pennies.
Broad bets on U.S. stocks have generally been a good bet for investors and therefore diversified index funds, both the VTSAX and the VFIAX stand a good chance at delivering great long-term results.
So the big question shouldn’t be, VTSAX versus VFIAX, but rather broad market passive index fund versus actively managed funds. Or better, single stocks. You will constantly be sold actively managed funds and single stocks because they make money for investment firms and investment managers. Avoid them like the plague. Have a long term horizon. Pick either the VTSAX or the VFIAX and continuously invest.
