Better Buy: Vanguard Total Stock Market ETF or Vanguard S&P 500 ETF?

Many investors subscribe to the idea of index investing, but figuring out which index fund they should own can leave them somewhat paralyzed.

Two common recommendations are the Vanguard Total Stock Market ETF (VTI +0.00%) and the Vanguard S&P 500 ETF (VOO +0.00%). Both Vanguard funds earn high marks from index investors thanks to their low expense ratios and strong track record of matching their respective indexes. Either could provide a great foundation for a portfolio.

Where they differ is in which index they track. The Total Stock Market fund tracks the CRSP US Total Market Index, which captures practically every investable U.S. stock in the market. The S&P 500 ETF tracks the S&P 500, which is a collection of about 500 of the largest U.S. companies that have been consistently profitable for at least a year.

Deciding between the two can be a challenge. So, here's what you need to know.

There's a lot of overlap between the funds

Both funds are weighted by market capitalization. That means the biggest U.S. companies like Microsoft and Apple make up a significant share of both portfolios. Meanwhile, smaller companies, like numbers 491 through 500 in the S&P 500 make up a much smaller share. As a result, there's a lot of overlap between the Vanguard Total Stock Market ETF and the Vanguard S&P 500 ETF.

The top 10 holdings in each fund are the same. Here they are and their respective weightings.

Data source: Vanguard. Data as of 3/31/2024.

Overall, 86% of the Total Stock Market ETF overlaps with the holdings in the S&P 500 ETF. As a result, the returns you can expect are very similar and highly correlated.

That leaves 14% of the Total Stock Market ETF invested in stocks outside of the S&P 500. These are mid- and small-cap stocks, or large companies that have yet to meet the profitability criteria for inclusion in the S&P 500 index. That amount of diversification is not insignificant, but it's not going to push the Total Stock Market ETF returns too far from the returns of the S&P 500 ETF.

Factors to consider for every ETF

There are some other important factors to consider, though. Let's take a look at them in the context of the Vanguard Total Stock Market ETF and the Vanguard S&P 500 ETF.

• Expense ratio: Expense ratio is the amount you'll pay as a percentage of assets to invest in a given fund. Most index funds offer very low expense ratios since there's no need to pay a fund manager to actively select individual stocks. Index funds simply respond to the market and the S&P selection committee. Both ETFs charge just 0.03% expense ratios.

• Turnover rate: Turnover rate is a measure of what percentage of assets a fund manager sells in a given year. A high turnover rate may indicate a poorly run index fund. Selling stock usually triggers a taxable event, but ETFs have a mechanism to avoid creating tax liabilities. Both ETFs had a turnover rate of just 2.2% in 2023.

• Tracking error: Tracking error measures how closely the price of the ETF reflects the value of the underlying index at any given time. A high tracking error can result in individual returns that don't match the promise of index funds -- that is, returns matching the market. If investors buy when an ETF is priced in excess of the index and sell when it's priced below the value of the index, they may end up costing themselves more than the expense ratio. The Vanguard S&P 500 ETF has managed a lower tracking error than the Vanguard Total Stock Market ETF: 0.02% vs 0.05%. But neither result is worrisome.

It might make sense to own both

You can't go wrong with either the Vanguard Total Stock Market ETF or the Vanguard S&P 500 ETF. Both offer very low expense ratios and turnover rates, and the difference in their tracking errors is negligible. The overlap in their holdings ensures that you'll get very similar returns going forward. The added exposure to mid- and small-cap companies through the Total Stock Market ETF does tilt its expected returns higher although that may take a very long time to play out.

If you want some added exposure to mid- and small-cap stocks, but not as much as the Vanguard Total Stock Market ETF provides, you could simply buy both. Splitting your money between the two evenly will put most of your investments in large-cap stocks, but around 7% in mid- and small-cap stocks outside the S&P 500. Although you can split your funds however you want. You may need to rebalance sometimes, but since the returns of each fund are so similar, you'll never stray too far from your target allocation.

At the end of the day, either or both funds can make a great cornerstone to your portfolio.