Chances are, a total stock market index fund could be—and probably should be—the largest part of your portfolio. Indexing the entire market is the favorite strategy of efficient-market theorists, but even adherents of active management generally advocate for a core holding in a broad-market index fund. Expense ratios are the most reliable predictor of future performance, and a total stock market fund can essentially guarantee you won’t trail the market. And with the recent launch of the 0% expense ratio
Fidelity ZERO Total Market Index
fund, such indexing is now free.
Yet it would be a mistake for every indexer to buy this fund (ticker: FZROX). With fees already as low as 0.03% at competitors, the savings would be minuscule.
Finding the best total market index fund now depends on other factors. A key one: portability. Fidelity’s new fund is available only to investors who buy it directly from Fidelity. It costs the company more to run than it charges investors. In other words, it’s a loss leader, to get clients in the door. “Our hope is that we’ll attract new clients that haven’t worked with us,” says Scott O’Reilly, Fidelity’s head of index funds.
In contrast, ETFs such as
Vanguard Total Stock Market
iShares Core S&P Total US Stock Market
(ITOT) can be traded anywhere. Fidelity investors who want some flexibility should instead buy
Fidelity Total Market Index Fund Premium
(FSTVX). Although it charges a 0.015% expense ratio, it’s available at other brokers.
That said, the transaction fees for trading mutual funds are generally higher than those for ETFs unless they’re on non-transaction-fee (NTF) platforms. So, for instance, at TD Ameritrade, you will pay $49.99 to buy or sell mutual funds from companies that have not struck deals to be a part of the NTF platform—a cost that is usually passed on to investors in higher annual fees. (Vanguard routinely refuses to pay to be a part of NTF platforms.)
If you’re an active trader, or simply invest regularly, like every paycheck, then buying a fund can be your most significant cost—5% of every $1,000 trade. Meanwhile, some total market exchange-traded funds are on NTF platforms. The iShares’ ITOT ETF is on five—ETrade, Ally, Fidelity, Vanguard, and Firstrade, while Vanguard’s VTI is on three of those.
There are numerous other factors to consider—tax efficiency, tracking error versus the benchmark, liquidity, manager trust, and the breadth of a total market fund’s stock coverage. While total funds are generally tax efficient because stocks rarely leave the benchmark, shareholder redemptions can force managers to sell appreciated stock to raise cash. ETFs have an added advantage here, as they provide in-kind redemptions of appreciated stock to special institutional investors known as authorized participants. That rids the fund of taxable gains without having to pay them out to shareholders.
Listen to a conversation between Jack Hough and Alex Eule on October’s market volatility and why panicking (a little) might be all right, in a recent episode of The Readback. You can sign up for the podcast in iTunes or wherever you listen to podcasts.
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Yet Vanguard is an odd duck in the ETF world, as its total market VTI is legally another share class of its total market mutual fund, instead of being a free-standing fund. That means taxable capital gains realized throughout the different total market fund share classes are distributed on a pro rata basis to each class, including to the ETF. Although it’s unlikely such distributions would materialize, as it would require a massive run of shareholder redemptions, the Vanguard ETF’s and mutual fund’s 41% unrealized potential capital gain exposure is more than any other major total market exchange-traded or mutual fund.
Morningstar analyst Ben Johnson has written about this risk, but considers VTI his favorite total market fund: “That fund has tracked its underlying benchmark perfectly, actually earned back its de minimus fee via savvy portfolio management techniques and securities lending techniques.”
Now that total market funds are commodities, investors should focus more on the overall package. Here again, Vanguard shines, Johnson says. “The Fidelity [zero fee fund] move is a loss leader, where they hope to make up the cost with the spread they’re going to earn on cash balances—money-market funds and bank type accounts, and anything else they can upsell their clients,” he says. “Subsequently, you’ve got Vanguard aggressively marketing the fact it has the highest money market yields of any brokerage platform out there, trying to wake people up to the fact there’s no such thing as free.”
That’s true, but there’s no reason you couldn’t use Vanguard as your broker, keep your cash in its high-yielding money-market funds, but buy a non-Vanguard total market ETF there. Vanguard in fact has facilitated this strategy by making it free to trade almost every ETF at its brokerage: Given that, BlackRock’s ITOT is the better total market ETF than Vanguard’s, and arguably, the best overall. It’s available on more NTF platforms, it’s 0.03% fee beats Vanguard’s 0.04%, it has less unrealized capital gains exposure, and it’s structured better, tax-wise.
Also, since ITOT shifted from the S&P Composite 1500 to the S&P Total Market Index in December 2015, it covers almost as many small and microcap stocks as Vanguard. According to Morningstar Direct, ITOT holds 3,401 stocks to Vanguard’s 3,667 (the most of any total market ETF). (Fidelity Zero has 2,508.) Moreover, since ITOT cut its expense ratio from 0.07% to 0.03% in November 2015, it’s had virtually zero tracking error with the benchmark, like Vanguard. Both ETFs are extremely liquid, having narrow trading spreads and trading only at slight premiums or discounts to their underlying portfolios. So ITOT wins—by a nose.