When it comes to finding an anchor for your investment portfolio, many investors search for securities and derivatives with broad exposure. One of the most popular portfolio anchors is the Vanguard Total Stock Market ETF (NYSEMKT:VTI). The ETF currently has about $36 billion in assets, while the Vanguard Total Stock Market Index Fund (including mutual-fund shares) has more than $287 billion in assets. In fact, Vanguard's fund surpassed PIMCO's Total Return Fund to become the world's largest fund in October.

Many investors prefer, and are comforted by, having a single core holding within their portfolio that gives them a feeling of diversification -- even if the extent of their diversification is simply a large basket of equities like Vanguard's Total Stock Market ETF. In any event, broad-reaching ETFs -- and mutual funds, for that matter -- also give risk-averse investors the opportunity to invest in the stock market without the pressure of trying to pick winners and avoid losers.

Index funds and index-tracking ETFs ease the pressures of selecting specific stocks because they're not overly weighted toward any particular equity. There are a few negative consequences to investing in index funds and ETFs, which I'll get to in a moment. First let's decide whether Vanguard's Total Stock Market ETF should be considered as a portfolio anchor.

A look at the performance
Rather than examining every holding in the Vanguard Total Stock Market ETF, let's compare its performance to that of the S&P 500. After all, Vanguard's ETF tracks the CRSP US Total Market Index (since June 3, 2013), which represents "nearly 100% of the U.S. investable equity market," according to CRSP. And the S&P 500 index "captures approximately 80% coverage of available market capitalization."

As you can see below, Vanguard's Total Stock Market ETF has outperformed the SPDR S&P 500 ETF (NYSEMKT:SPY), which tracks its namesake index, over several time frames. There are two reasons why Vanguard's fund outperforms SPDR's ETF. First, the small-cap and micro-cap stocks included in Vanguard's ETF pull just enough weight to give the ETF a slight competitive advantage. Secondly, Vanguard's ETF has historically had a lower annual expense ratio.

Time Frame

VTI Gain

SPY Gain

Net Difference

Year to date




1 year




2 years




5 years




Since June 15, 2001




Performance comparison of VTI and SPY.

It is intuitive that a lower annual expense ratio will improve performance over time, but the big difference-maker is the Vanguard Total Stock Market ETF's allocation to smaller companies. As of Oct. 31, the ETF is comprised of 2.42% micro-cap stocks, 6.34% small-cap stocks, and 19.25% midcap stocks.

The 8.76% in micro-cap and small-cap positions may seem minuscule, but it makes all the difference. Why do small-cap stocks outperform and give the Vanguard Total Stock ETF an advantage over the SPDR S&P 500 ETF?

First, with greater risk comes the potential for greater reward. Micro-cap and small-cap stocks carry greater risk than the established giants, but they can experience phases of explosive growth, with revenue and income increasing by several hundred percent year over year. This usually leads to a much greater demand for outstanding shares, because the fair market price is a derivation of future discounted cash flows. Therefore if earnings grow more than expected, the future discounted cash flows of the company will also increase, and this will cause a stock's price to adjust to the new fair market value.

For example, say you buy shares in a company that is expected to grow at a rate of 10% for the next three years and 5% for the following three years. If the expected growth rate jumps to 20% for the next six years, then you can expect to see the stock's price rise.

This is how the micro-, small-, and midcap holdings in the Vanguard Total Stock Market ETF, despite their minority allocation, have helped the ETF consistently outperform the S&P 500.

Back to reality
It goes without saying that a pure equities holding is not be the best investment during a market collapse. Further, an equities position with about 28% in micro-, small-, and midcap holdings will suffer more than a pure large-cap and megacap position. This is an important consideration when the markets are near all-time highs, as they are now. I do not expect a recession anytime soon, but a severe correction is imminent.

Further, bond rates will inevitably rise. When this happens, we will see a correction in the equities markets, because conservative investors are much more at ease investing in bonds that satisfy their income needs. However, a correction at this point will be like a welcome summer rain storm, ultimately allowing more money to pour into the markets at more reasonable entry points.

This brings me back to Vanguard's Total Stock Market ETF. Currently, the ETF is at all-time highs. This is not the best time to buy into a new equity position -- especially a broad-based equity position that simply corresponds to everything else. However, if you are looking for a long-term play in the stock market but do not feel confident that you can "pick winners" or that someone else can do it for you, then Vanguard's Total Stock Market ETF may be a great portfolio anchor for you. I must warn you that some short-term pain will likely come along the way. However, this short term pain opens up the opportunity to average your way into a healthy long-term position.

Fool contributor Spencer Knight has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.