Is a Total Stock Market Fund a Good Investment Strategy?

I’m investigating alternative strategies for my 401k. In the prior post I demonstrated investing in the full S&P 500 provided better returns (both cumulative and annual) than just the top 100 companies in the index. Now I want to look at another approach, could it be better to invest in a total stock market mutual fund than to invest in three separate mutual funds representing each category of capitalization?

Vanguard’s Total Stock Market Index Fund (VTSMX) replicates the performance of the entire US stock market: large caps, mid caps, small caps and even micro-cap stocks. I currently own large cap (FUSVX), mid cap (FSCKX) and small cap (FSSVX) index funds in my 401k. Since VTSMX includes all these same stock categories in one fund a logical question would be can I scrap my three funds in exchange for VTSMX? I could save on fees by doing so and it is much easier to manage one fund than it is three.

To test I looked at the annual and cumulative returns at various allocations. Since my small cap and mid cap Fidelity mutual funds only go back to 2011, I used iShares Mid Cap Index ETF (IWR) and Small Cap Index ETF (IWM) for the test, both of those ETFs go back to 2000 and 2001 respectively. Also note this model starts off with a one time $100k investment made in 2002, this is different from how 401ks are normally funded. That said this will still provide a great approximation for which option provides the best return.

Cumulative returns of VTSMX vs alternative options

As you can see the various mixes of large cap, mid cap and small cap mutual funds significantly outperform VTSMX, and its not just the cumulative results – their performance is better annually too:

Table of Cumulative returns of VTSMX vs alternative options

Out of the 15 years analyzed VTSMX had the best annual returns for only 5 years which is obviously not a very stellar rate (LeBron’s NBA Finals rate is even better). Also, when it did have the best annual returns it only beat by an average of 1.21% as opposed to the 10 years where it had the worst returns it loss by an average of 2.96%.

You can see from the table and the chart the best option is 1/3 large cap, 1/3 mid cap and 1/3 small cap allotment. This allocation had the best annual returns 10 out of the 15 years tested and the best cumulative return. This surprised me because I didn’t realize the mid caps and small caps would have such an impact on the returns. You can also see the increased allocation of small and mid cap stocks increases the volatility of the portfolio, this makes sense because there is usually a really strong risk reward relationship in investing.

Cumulative returns of VTSMX vs alternative options
Cumulative returns since 2007.

Now, lets not declare victory on this just yet. You can see in the above table starting at 2007 it appears the annual returns between VTSMX and the other 3 options may be about even.

Looking at the chart it is too close to call. The table below displays the cumulative returns from 2007 and 2012 and it clearly shows which option has the best performance.

The cumulative returns for each option are relatively close. However, the one-third portfolio still has the greatest returns at all three starting points (2002, 2007 and 2012) making it the clear winner. Even though the 2007 and 2012 analysis showed only a thin difference in returns, that’s still real money! Imagine if we started with $1 million dollars instead of $100k, a 1% difference in cumulative returns would be a huge gigantic deal!

Based on this research I’ll definitely pass on pursuing investing in a total stock market index fund or ETF. This approach isn’t really going to juice up my 401k returns, I need something far more substantial. At least for now I can mark this option off my list.


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