2023-05-31 05:28:39 ET
Summary
- The Vanguard Total Stock Market Index Fund ETF offers broad diversification, low fees, and dividend growth for investors seeking exposure to the US equity market.
- Dollar-cost averaging and managing investment expenses can help investors maximize returns and maintain disciplined investment habits.
- Despite some concentration in mega capitalization stocks, VTI ETF remains a profitable option for long-term investors.
The Vanguard Total Stock Market Index Fund ETF ( VTI ) is one of the largest exchange-traded funds that tracks the performance of the entire US stock market, including companies of all sizes from micro to mega capitalization. It aims to replicate the performance of the CRSP US Total Market Index, which is a broad-based, market-capitalization-weighted index that covers roughly 99% of the US equity market and nearly 4,000 stocks. As of December 2020, the ETF had over $1 trillion in assets under management and a net expense ratio of just 0.03%, making it a low-cost option for investors seeking nearly the most diversified exposure possible to the US equity markets.
The core tenets of a well-structured investment portfolio, for the majority of people, are centered around diversification and investment expense management. Some advisors even tell clients to allocate some money to fixed income and perhaps even private equity, but for a simplified investment approach, one might just buy an ETF like this one and still find success. Keeping things simple has some advantages.
Jack Bogle's Legacy
Jack Bogle was a well-known American investor and the founder of the investment management company Vanguard Group, a multi-trillion dollar organization. He created the first index fund, which transformed the way investors approach the entire stock market and individual investing. Bogle believed in providing low-cost investing options for ordinary Americans, free from high fees and exorbitant expenses, leading him to create the first index fund, based on the S&P 500 for investors in 1976. Bogle passed away on January 16, 2019, leaving behind a legacy that has transformed the way people invest.
Probably one of the most interesting facts about Bogle was that he was born in 1929 into a family that had been wiped out by the market collapse of that year. His formative years were spent growing up during the Great Depression and learning the lesson of how rampant speculation can destroy wealth. Luckily, a wealthy uncle, who was not wiped out in 1929, paid for his education and helped to send him to a long multi-decade career in finance. The result is an investment philosophy followed by millions that reaps the reward of long-term gains, low fees, and no fear of market downturns because the best time to buy is when the market is down.
Valuation
Overall, equity valuations are not the lowest they have ever been. In fact, there is a strong case that equities are slightly overvalued. As you can see here, the price to earnings ratio on this index is 19.7. It's possible the index is overdue for a correction.
Equity Characteristics (Vanguard.com)
Take note, if the index does correct, the best thing to do would be to buy more and hold what you have. See the section on dollar cost averaging to understand this better.
Diversification
Being diversified in an ETF like Vanguard Total Stock Market Index Fund ETF holding nearly 4,000 equities can help reduce risk because as some investments do well, others may still suffer poor performances. By spreading investments across various industries and types of stocks, mitigating potential losses in some areas can be accomplished, and overall portfolio performance will follow the overall market higher over time.
Diversification helps protect a portfolio by reducing risk through investing in a variety of different equities. For example, if investors put all of their money into one or two stocks and those stocks experiences a significant drop in value, the investors could lose a large portion of their portfolios. However, if the investors diversify by investing in multiple stocks, bonds, and other assets, the negative impact of one asset's drop in value on the overall value of the portfolios is mitigated. This strategy of diversification can protect the investors from significant losses and help ensure long-term growth of their portfolio.
One issue with this fund is the over-exposure to some of the mega capitalization equities of this market like Apple ( AAPL ) and Microsoft (MSFT), which make up 11.4% of the total holdings. For an index fund that is supposed to be broadly diversified, this exposure seems a little too high. In total, nearly a quarter of this funds holdings are concentrated in the top 10 largest holdings, all mega capitalization companies.
Top Ten Holdings (Vanguard.com)
To reduce exposure to mega capitalization stocks, one might put a portion of their holdings in SPDR® Portfolio S&P 600™ Small Cap ETF ( SPSM ) and the Vanguard Mid-Cap Index Fund ETF (VO), which would increase holdings in small and mid capitalization stocks. For instance, allocation of 25% to each of these small and mid-cap funds and 50% to the Vanguard Total Stock Market Index Fund ETF would effectively reduce an investor's overall exposure to a company like Apple from 6.1% to about 3%.
However, despite these concentrated positions in mega capitalization stocks, the average investor could also be fine with holding these companies, due to knowing and understanding their businesses and how the economy impacts their growth and strength. A simplified investment approach could be to buy and hold Vanguard Total Stock Market Index Fund ETF and not worry about the exposure to mega capitalization companies.
Dividends
Dividend growth can have a significant impact on your financial well-being, creating a passive income stream. When dividends increase over time, it not only provides investors with a steady stream of income but enhances the overall value of their investment portfolio, if reinvested. In this instance, VTI paid a dividend of $1.67 per share in 2012, and in 2022, it's paid $3.26 per share. If you had invested $10,000 in this ETF in 2012, at $70/share, with a dividend yield of 2.4%, your annual dividend income would have been $238. In 2021, your annual dividend income would have grown to $466, providing investors with a 96% increase in their income in just nine years.
Furthermore, an increase in dividend payments can provide financial security during bear markets. Dividends provide a stable stream of income for investors regardless of market conditions, which allows an investor to hold onto equities during periods of weakness. Reinvesting those dividends can help to compound returns over time, which can boost portfolio performance during both bull and bear markets, but especially bear market if investors can buy at a low price.
Dollar Cost Averaging
Dollar cost averaging is a strategy that involves investing a fixed amount of money at regular intervals, like months, over an extended period of years. Most people are doing this already if they have money withheld from a paycheck to contribute to a retirement account like a 401k. The goal of this strategy is to minimize the impact of market volatility on investment returns. By consistently investing the same amount of money each period, an investor can buy more shares of an investment when the prices are low and fewer shares when the prices have risen. This strategy reduces your average cost of buying stocks over time, which can help reduce the risk of buying at a market peak.
An advantage of dollar cost averaging is that it promotes disciplined investment habits and eliminates the tendency of investors to try and time the market. By committing to investing a fixed amount of money at regular time intervals, investors can avoid the temptation to make emotional investment decisions, which are sometimes counter-productive to long-term gains. This can help them stay focused on the long-term and avoid the urge to panic during market corrections.
Managing Investment Expenses
Managing investment expenses is a critical aspect of successful long-term investing. This involves monitoring all of the various fees associated with investments, such as mutual funds, exchange-traded funds, and managed brokerage accounts. Excessive fees can significantly damage the returns generated by these investments, reducing overall potential compounded growth. By keeping a close eye on all of the various investment expenses, investors can maximize their returns and achieve their financial goals more quickly. Vanguard Total Stock Market Index Fund ETF has a total expense ratio of just 0.03%, making it one of the cheapest options around. Compare this to an actively managed investment portfolio that can cost as much as 1% of total assets in some cases.
The 10-Year average return on the Vanguard Total Stock Market Index Fund ETF has been about 11.62% (Vanguard Mutual Fund Profile | Vanguard ). Let's compare how the difference in fees could impact an investor's return with a hypothetical example. In this example, we see the compound growth of two portfolios, one with a minimal 0.03% fee and one with active management fees of 1%.
Comparison of Investment Fees (Original Creation)
In the graphics shown above, the higher 1% management fees start by taking a smaller portion of the investor's gains, but when those gains are reinvested, the impact becomes greater over time. By the time the investor gets to year 10, the compounded growth and loss of investment gains amounts to 23.8% of the total original amount invested. It pays to keep fees low.
Conclusion
Investing in the Vanguard Total Stock Market Index Fund ETF has the potential to generate decent returns for investors. Diversification and dividend growth are great ways to preserve capital and increase overall wealth. Additionally, index funds, like this one from Vanguard, offer extremely low fees (0.03%) compared to actively managed funds, resulting in more money staying in investors' portfolios for compound growth. With dollar-cost averaging, investors can put their investment savings on auto-pilot, taking advantage of downturns in the market.
Overall, the combination of dividend growth, low investment fees, broad diversification, and dollar-cost averaging makes investing in Vanguard Total Stock Market Index Fund ETF a profitable option.
For further details see:
VTI: A Top Pick For Long-Term Investing