Creation Date: 04/24/2008
Contents
Introduction
Vanguard Total Stock Market Index Fund is the company's most widely diversified U.S. stock fund, presently tracking the MSCI U.S. Broad Market Index. According to the fund's prospectus, this index
"... represents 99.5% or more of the total market capitalization of all the U.S. common stocks regularly traded on the New York and American Stock Exchanges and the Nasdaq over-the-counter market. The Fund typically holds 1,200–1,300 stocks in its target index (covering nearly 95% of the Index’s total market capitalization) and a representative sample of the remaining stocks. The Fund holds a broadly diversified collection of securities that, in the aggregate, approximates the full Index in terms of key characteristics. These key characteristics include industry weightings and market capitalization, as well as certain financial measures, such as price/earnings ratio and dividend yield."
The Fund Holdings page on the Vanguard website reports that as of 03/31/2008, the fund invests in 3544 stocks, while the benchmark index includes 3794.
Share Classes
Three share classes are available to individual investors:
- Investor (VTSMX), with an expense ratio (ER) of 0.15% and an initial minimum investment of $3,000
- Admiral (VTSAX), with an ER of 0.07% and a minimum investment of $100,000, except $50,000 suffices for conversion of an Investor Shares account in existence 10 years
- ETF (VTI), with an ER of 0.07% and no minimums, though transaction costs apply in buying and selling through a brokerage
Total costs of the ETF and open-end classes may be compared via this Vanguard calculator.
Two additional share classes are offered through some workplace retirement plans:
- Signal (VTSSX), with an ER of 0.07%
- Institutional (VITSX), with an ER of 0.05%
Advantages
Broad Coverage
Since the Vanguard Total Stock Market Index Fund mirrors almost perfectly the broad capitalization-weighted U.S. equity market, it is appropriate for most individuals as the main (or only) holding in this asset class. The fund also has a unique performance advantage. Its shareholders possess the same portfolio as all other U.S. equity investors, taken in aggregate. The performance before costs of these two groups is therefore equal. After costs, the Total Stock Market Index investors have a significant edge.
Tax Efficiency
Total Stock Market Index Fund is quite tax-efficient, making it a suitable holding for a taxable account. Because successful stocks almost never leave its benchmark index, the fund doesn't generally realize capital gains by selling securities. The existence of an ETF share class is also helpful in this regard, since when institutional investors redeem creation units for their constituent stocks, Vanguard uses the opportunity to dispose of low-basis lots. About the only scenario under which the fund could realize large capital gains is massive shareholder redemptions, unlikely in the absence of an unprecedented market crash (which would in itself solve the capital gains problem). It should be noted that the net purchase of the fund has been positive for 15 years in a row since 1993 even though the period includes several market downturns. This suggests that most redemptions can be handled without selling underlying shares, contributing more to the tax efficiency of the fund.
The fund's dividend yield, being in line with the U.S. market's, is not unusually high. Further, most or all of the fund's income should be in the form of qualified dividends, currently taxable at a 15% rate or less. The fund's dividends were 100% qualified in 2004, 2005, 2006, and 2007.
Criticisms
Size and Style
Academic research indicates that small value stocks have outperformed other equity categories in the past. Being capitalization-weighted, Total Stock Market Index doesn't have a large percentage of its assets in small value stocks. Applying Morningstar Instant X-Ray to VTSMX gives 4%, though such numbers are heavily dependent upon an information provider's exact size and style definitions.
Bubble Risk
If a group of stocks becomes irrationally popular, their market capitalizations increase, so they are more heavily weighted in the Total Stock Market Index Fund. This effect, which depends upon the belief that stock sectors can become significantly mispriced, may lead to sharp fund declines when the bubble bursts, i.e., the overvaluation unwinds itself. An obvious example, with benefit of hindsight, is the technology boom of the late 1990s followed by the 2000-2002 bust.
Fidelity's Lower Cost Alternative
For investors contemplating VTSMX, the Fidelity Spartan Total Market Index Fund - Investor Class (FSTMX) is slightly cheaper, with an ER of 0.10% and an initial minimum of $10,000. FSTMX has the Dow Jones Wilshire 5000 as its benchmark index.
Performance
This historical returns webpage provides VTSMX performance for each of the 15 full calendar years the fund has been in existence. During this 1993-2007 period, the fund had an average annualized return of 10.31%. Its best calendar year result was +35.79% (1995), and its worst was -20.96% (2002). Its tracking error relative to its benchmark varied from -0.66% (1993 & 1995) to +0.32% (2000).
History
Upon its inception in 1992, VTSMX took over the role as a typical investor's plausible core U.S. stock holding, succeeding the venerable 500 Index Fund.
Inception dates of the various share classes are as follows:
- Investor: 04/27/1992
- Institutional: 07/07/1997
- Admiral: 11/13/2000
- ETF: 05/24/2001
- Signal: 09/01/2006
The fund made a minor change of benchmark on 04/22/2005, moving from the Dow Jones Wilshire 5000 Index to the MSCI U.S. Broad Market Index.
Links
Investing in Total Markets (paper by John Norstad)
Vanguard Index Fund Tax Attributes FY-2007 (monograph by Barry Barnitz) contains tax data on the fund
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