What's the best core holding for long-term investors?
08 October 2018 | Markets and Economy
Many investment experts have long cited the S&P 500 index as the best way to get exposure to the US equity market for long-term investors seeking a core exposure. In fact, some also feel that an S&P 500 index based investment fund would suit anyone seeking a global exposure since the underlying companies are large US based multinationals that generate a significant portion of their revenues and profits from the rest of the world. Indeed, an analysis of the revenues of these companies shows that almost 25% of revenues are generated from outside the Americasi.
S&P 500 index: broad, but concentrated
With the S&P 500 index having recently made headlines as it continues its longest ever rally (almost ten years and counting), you would have been well rewarded if you had chosen this option. And, as the index covers around 82% of the US equity market, it certainly does provide investors with a broad based exposure to US equitiesii.
However, critics of the index argue that it is too concentrated and not diverse enough. They say that the strength in recent years has been driven in part by the information technology sector and, in particular the so-called FAANGs – the tech giants Facebook, Amazon, Apple, Netflix and Google's parent company Alphabet. With the sector making up 26.5% of the index (and the FAANGs alone half of this), this would be hard to argue withiii.
A total stock market approach
An alternative to the S&P 500 could be a total stock market fund. Given its broader coverage of stocks it provides investors with more diversification, as well as more exposure to smaller companies. Although smaller companies can carry more risk, over time, they have a history of outperforming larger ones. This could therefore enhance overall returns for an investor in the long-term.
A total stock market fund would naturally include all the companies with the S&P 500 index. And given that these funds often invest based on market-weights, the top holdings would also be identical to an S&P 500 index based investment. However, they would be less concentrated, improving overall diversity and reducing single stock risk. Therefore, such a fund could provide investors with a better overall risk profile, despite an increased exposure to smaller companies.
By way of comparison, the Vanguard US Equity Index Fund, which takes a total stock market approach, has almost seven times as many holdings as the Vanguard S&P 500 UCITS ETF (3,479 vs 507) and its top ten holdings are also less concentrated (19.1% vs 23.3%)iv.
So while an S&P 500 based investment will suit many investors, for those who don't own any other US funds, who don't have exposure to small caps or just want a more diverse portfolio, a total stock market fund could provide a low-cost, all in one investment solution.
Senior investment planner, Vanguard UK
iSource: S&P Dow Jones Indices LLC and FactSet. Data as at December 2017.
iiSource: S&P Dow Jones Indices LLC. Data as at December 2017.
iiiSource: S&P Dow Jones Indices LLC. Data as at August 2018.
ivSource: Vanguard. Data as at August 2018.
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