VTI - VTI Continues To Underperform The S&P And I'd Rather Be In VOO

2023-11-17 09:00:00 ET

Summary

• Index funds like VTI and VOO are popular for building wealth with low-cost and simple investing.
• VOO has consistently outperformed VTI in terms of returns over various time periods.
• If a recession occurs in 2024, VOO is expected to continue outperforming VTI due to its exposure to larger, more stable companies.

Index funds are instrumental for many individuals to build wealth. Total market and S&P 500 index funds are two of the most common index funds with staggering assets under management ((AUM)). Many large financial institutions have low-cost index funds that make investing in the market inexpensive and simple, as investors don't need to conduct as much research as if they were allocating capital toward individual equities. The Vanguard Total Stock Market Index Fund (VTI) is one of the largest total market index funds with $1.27 trillion in AUM, while the Vanguard S&P 500 ETF (VOO) is rapidly approaching the $1 trillion AUM level with $851.21 billion in AUM. VTI and VOO have both delivered substantial gains over the years and provide investors with vehicles to grow their capital, but I would rather allocate capital toward VOO. VTI has trailed VOO in performance, and if the economy cracks in 2024, I believe VOO will continue to outperform VTI.

Following up on my previous article regarding VTI

At the beginning of July, I wrote an article on VTI ( can be read here ) and discussed why I felt VTI was a tier below VOO as an investment option. After 4 ½ months of additional economic data, I wanted to provide an update on this thesis and expand into why I think VOO will be more stable if a recession occurs in 2024. I am still neutral on VTI and feel it's a strong investment product for investors to gain exposure to the total market, but I can't get bullish on VTI as I am looking for performance, and it continues to lag VOO.

Returns from VTI continue to underperform compared to VOO making it an inferior option for me to allocate capital toward

Whether your allocating capital toward a total market index or an S&P 500 index fund, you're buying a basket of equities to mitigate risk and grow the invested capital over time. Both total market and S&P index funds have accomplished these goals for investors over the years, but I continue to choose S&P 500 index funds over total market index funds. Specifically, I own shares of VOO rather than VTI because of the compared performance. The capital I am allocating toward index funds is capital I am not looking to touch for decades. I have a long time horizon, and I am not looking to beat the market with this capital, I am looking to have it grow with the market over time. The question for me has been which subset of the market, and the S&P continues to be where my capital goes.

VTI has an inception date of 5/24/01, and VOO went public on 9/7/10. I will be using data since VOO's inception to compare the two funds. Since 9/7/10, VTI has appreciated by 280.13%, and VOO has appreciated by 295.09%. As I indicated earlier, both ETFs have done an exceptional job at mitigating downside risk and growing invested capital, but lost percentage points correlate to less total return. For every $10,000 invested, VTI would have generated $28,013 in gains, while VOO would have generated $29,509. The total investment based on appreciation for VTI would be $38,013 compared to $39,509 for VOO. While both investments have done well, I would argue that $1,496 is an extra 3.79% that could have been generated over the same time period on invested capital. 3.79% may not seem like a lot, but when you extrapolate this out and look at the growth of $100,000 or $1,000,000 since 9/7/10, an investment in VTI would have trailed VOO by $14,960 or $149,600. To me, it doesn't matter if you had invested $10,000, $100,000, or $1,000,000, 3.79% makes a significant difference.

When I look at shorter time periods, VTI still trails VOO. Over the previous 5-years, VOO has appreciated by 64.09% compared to 58.52% for VTI. Looking at 2023, VOO has appreciated by 17.87% while VTI has appreciated by 16.6%. Since VOO became an alternative to VTI, it has outperformed VTI since inception, over the past 5-years, and on a YTD basis. As part of an overall diversified portfolio, I see a place for total market funds, but if I were going to pick VTI or VOO to allocate capital toward, VOO continues to be a stronger investment vehicle. There is a significant amount of data, and a significant amount of returns continues to be left on the table by picking VTI over VOO.

Despite CPI data, cracks in the economy are starting to show and if a recession occurs VOO is likely to continue outperforming VTI

For the past several months, I believed that while a recession is imminent at some point in the future, we wouldn't experience one in 2024. Based on recent economic data, I am starting to change my economic outlook for 2024 as I see more cracks forming in the economy. While the latest CPI data sparked a rally in the markets and reduced the likelihood of a rate increase at the December Fed meeting, cracks are forming throughout the economy. VTI tracks the total market index, which is comprised of large, mid, and small-cap equities across growth and value styles, while VOO tracks the S&P 500 , which represents the 500 largest companies in the United States. There is a chance that the recent CPI readings are giving the market a false sense of stability, and if the Fed remains hawkish, they could send the economy into a recession, which should impact VTI more than VOO.

As most readers are probably aware, inflation reached the highest point in four decades, which caused the Fed to raise rates to their highest levels since pre-financial crisis. Since topping out in 2022 at 9.1%, inflation has declined to 3.2% as of the latest CPI report. The 3.2% CPI print sparked a rally in the equity markets as it was a significant MoM decline from 3.7% and under the consensus estimates of 3.3%. The prior week, Chair Powell spoke on a monetary policy discussion panel at the 24th Jacques Polak Annual Research Conference in Washington, DC ( can be watched here ), where he remained overly hawkish before CPI data was released. While there is a lot of speculation that the Fed is done raising rates, the Fed has not singled that their job is done, and we have made this mistake before where we thought the Fed should have stopped raising rates, but they didn't, and have kept them higher for longer.

Over the past 5 quarters, bankruptcies in the United States have accelerated. While bankruptcies have increased, so has the unemployment rate, as it's at the highest it's been in over three years. As unemployment and bankruptcies continue to tick higher, consumer sentiment has declined for four consecutive months. The combination of higher rates and elevated bankruptcies are causing unemployment rates to increase. We lived through a period of expansion when the cost of capital was extremely low due to a Fed Funds rate that was basically non-existent. Now, there is a wall of debt to the tune of $1.8 trillion coming due over the next two years, according to Goldman Sachs (GS). The issue is companies took out loans when money was cheap, and rates have ballooned where the new rates could exceed their profitability models. Goldman Sachs has found that for each additional dollar of interest expense, firms lower their capital expenditures by 10 cents and labor costs by 20 cents. When this occurs, roughly half of the reduced labor costs are driven from reduced employment, while the other half comes from lower wages. If the Fed keeps rates higher for longer, it could cause businesses to experience increased interest expenses, which could correlate to additional layoffs that could drive unemployment higher.

Higher unemployment is the last thing the market wants. The last twelve recessions occurred during periods where unemployment increased by at least a percentage point. If the Fed stays higher for longer than, the cost of refinancing debt will add to future interest expenses, which would impact smaller and midcap stocks more than large caps. If the Fed pushes us into a recession and cuts rates to restimulate the economy, past trends indicate that unemployment will significantly increase during these periods, which is also likely to impact smaller and midcaps rather than large caps. Going into 2024, I think that VOO is positioned to outperform VTI again as the companies found within VOO have stronger balance sheets and are more likely to withstand either a high for longer rate environment or an economy that is pushed into a recession.

Conclusion

While CPI data was a step in the right direction, we're far from a risk-on environment. Cracks are showing in the economy, and the next several Fed meetings will be critical for what the economy looks like in 2024. No matter what period I looked at since VOO was created, it has outperformed VTI, and given VTI's exposure to small caps, it's not likely to outperform VOO in 2024 if a recession occurs. While VTI and VOO are both strong investment vehicles, I would rather be in the largest companies for the next several years as they have the balance sheets to withstand extended periods of uncertainty and the ability to manage debt better than small caps if a higher for long environment occurs. I am neutral on VTI as it has continuously trailed VOO, and I would rather deploy capital to VOO than VTI.

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