When evaluating long-term investment strategies, two prominent names often rise to the surface: SP 500 funds like iShares Core S&P 500 ETF (IVV) and total market indexes like Vanguard Total Market ETF (VTI). Both are favored by different camps, each with compelling arguments. Let's explore the 'Roth IRA Spark vs. Vanguard Go Long' debate, diving deep into earnings growth, risk, sector allocation, and fees.
On one hand, we have 'Roth IRA Spark', a strategy that focuses heavily on broad-based, passively managed SP 500 funds. Proponents argue that this strategy's simplicity and low costs make it an enticing choice for long-term investors. On the other hand, there's 'Vanguard Go Long', which advocates for a total market approach, capturing not just large-cap stocks but also small and mid-cap companies. This strategy is backed by the efficient frontier theory and is favored by financial advisors like Rick Ferri and Larry Swedroe.
Earnings Growth: S&P 500 vs. Total Market
Historical data indicates that total market indexes have shown impressive earnings growth. According to a study by Vanguard, over the 20-year period ending December 2020, the total U.S. stock market index had higher earnings growth than the S&P 500 index in 12 out of those 20 years.
However, it's essential to note that the S&P 500 heavily weights large-cap stocks, which tend to have more established earnings growth. Nevertheless, total market indexes offer the diversification of small and mid-cap stocks, which can drive earnings growth through innovating disruptively.
Large-Cap Dominance of S&P 500
The S&P 500 comprises the 500 largest U.S. companies by market capitalization. This concentration can lead to significant sector allocation tilt, with information technology, healthcare, and consumer discretionary stocks commanding the highest weightings. While this has historically served investors well, it introduces concentration risk.
Furthermore, large-cap stocks may miss out on growth opportunities in smaller, more agile companies. The S&P 500's exclusion of these stocks could be a notable weakness in certain market environments.
Diversified Earnings: Total Market Indexes
Total market indexes provide ample exposure to small and mid-cap stocks, diversifying your earnings sources. While these smaller companies may have higher volatility, they often provide extensive growth opportunities, particularly in early-stage industries like technology and healthcare.
Moreover, total market indexes capture a broader swath of the U.S. economy, reducing sector-specific risks. Instead of being heavily weighted towards information technology and healthcare, total market indexes offer a more balanced exposure to various sectors.
Risk: Volatility & Concentration
The volatility of total market indexes can be a double-edged sword. While they offer access to growth-oriented small and mid-cap stocks, these assets can be more volatile, leading to portfolio fluctuations. However, history shows that this volatility often smooths out over extended holding periods.
Contrarily, the S&P 500's large-cap orientation can create significant concentration risk, especially when a few stocks, like Apple or Amazon, drive most of the index's performance. If these companies face headwinds, the entire fund could suffer considerably.
Small-Cap & Mid-Cap Volatility
Indeed, small and mid-cap stocks experience more price volatility than their large-cap counterparts. However, this volatility can frequently translate into higher long-term returns. A study by Dimensional Fund Advisors found that, over the 48 years ending December 2020, the smallest stocks in the U.S. stock market returned 12.9% annually, compared to 10.2% for the largest stocks.
Nevertheless, investors should be prepared for extended periods of underperformance in these segments, as seen in certain market cycles, such as the late 1990s and early 2000s when growth stocks – predominantly small and mid-caps – significantly outperformed value stocks.
Concentration Risk of S&P 500
The S&P 500's focus on large-cap stocks introduces concentration risk. A few stocks can drive the entire index's performance, as shown by the increased weightings of information technology and healthcare stocks in recent years. As a result, any downturn in these sectors could disproportionately impact the index.
To mitigate this risk, some investors opt for equal-weight S&P 500 funds or implement a broader total market strategy that offers more diversification across market capitalization.
Costs: A Tale of Two Funds
When it comes to fees, neither 'Roth IRA Spark' nor 'Vanguard Go Long' can be accused of being greedy. Both IVV and VTI offer low-cost passive management solutions.
IVV, with an expense ratio of 0.03%, is an attractive option for investors seeking a low-cost, broad-based solution. Meanwhile, VTI, with an expense ratio of 0.03%, is among the most affordable total market funds available.
Expense Ratios: IVV vs. VTI
The difference in expense ratios between IVV and VTI is negligible, making costs a less critical factor in deciding between the two strategies. Instead, other considerations, such as earnings growth, risk, and sector allocation, often play more substantial roles in an investor's decision.
Moreover, both funds are passively managed, further reducing costs. This low-cost structure allows investors to keep more of their returns and serves as a potent tool for long-term wealth building.
In summary, the 'Roth IRA Spark' vs. 'Vanguard Go Long' debate is more about trade-offs than clear-cut superiority. Both strategies offer unique advantages, and the best choice depends on an investor's individual goals, risk tolerance, and time horizon. When contemplating this debate, investors should think critically about their risk appetite and long-term objectives, reflecting on whether the potential growth of total market indexes or the risk mitigation benefits of the S&P 500 better align with their needs. The final decision should be a considered, personalized one, best made in consultation with a financial advisor.