You’ve decided to start investing. You’ve opened a brokerage account, and you’re ready to buy a low-cost index fund to capture the growth of the U.S. economy. But then you see them: two seemingly similar options that have you scratching your head.
One is an "S&P 500" fund. The other is a "Total Stock Market" fund. Both sound like they track the stock market, so what’s the real difference? Does it matter which one you choose?
It’s a fantastic question and one that trips up many new investors. The good news is that both are excellent tools for building wealth. The better news is that understanding the distinction is straightforward.
Let's break down the All-Stars from the entire league.
Understanding the S&P 500: The League of Captains
Think of the S&P 500 as the league’s All-Star team or a roster of the industry’s most established captains. It’s an index that tracks the performance of 500 of the largest U.S. publicly traded companies.
Here’s the key takeaway: It’s not just any 500 companies. It's the 500 largest, chosen by a committee to represent the core of the U.S. economy.
- Focus: Large-Cap Stocks (short for large-capitalization). These are the behemoths—the Apples, Microsofts, Amazons, and Johnson & Johnsons of the world.
- Representation: Despite having "only" 500 companies, the S&P 500 makes up approximately 80% of the total value of the U.S. stock market. Because it’s market-cap-weighted (meaning the bigger the company, the more impact it has on the index’s performance), its movements closely mirror the broader market.
- Vibe: It's a bet on America's biggest and most dominant companies.
Understanding the Total Stock Market: The Entire League
If the S&P 500 is the All-Star team, the Total Stock Market is, well, the entire league. A total stock market index (like the CRSP US Total Market Index or the Wilshire 5000) aims to capture virtually all U.S. stocks that are readily available for purchase.
This means it includes everything in the S&P 500, plus thousands of other companies.
- Focus: All-Cap Stocks. It includes large-caps, mid-caps, small-caps, and even micro-caps. You get the established giants and the smaller, potentially faster-growing companies.
- Representation: It represents nearly 100% of the investable U.S. stock market.
- Vibe: It’s a bet on the entire U.S. economy, from the giants on down to the ambitious startups just making their public debut.
Head-to-Head Comparison: S&P 500 vs. Total Stock Market
Let's put them side-by-side to see the differences more clearly.
|
Feature |
S&P 500 Index |
Total Stock Market Index |
|
Number of Holdings |
~500 Companies |
~3,000 - 4,000+ Companies |
|
Scope |
Large-Cap Stocks Only |
All-Cap Stocks (Large, Mid, Small, Micro) |
|
Market Coverage |
~80% of U.S. Market Value |
~100% of U.S. Market Value |
|
Diversification |
Excellent, but focused on large caps |
Maximum diversification across all company sizes |
|
Top Companies |
Heavily weighted to the top 10-20 stocks |
Also heavily weighted to the top 10-20 stocks (which are the same as the S&P's), with thousands of smaller companies making up the rest. |
Performance and Risk: Does the Difference Matter?
This is the crucial question. If you look at a chart of their performance over the last 10, 20, or 30 years, you’ll see two lines that move almost perfectly in lockstep.
Why? Because the S&P 500 makes up such a huge chunk of the total market, it is the dominant force. The performance of the thousands of smaller stocks in the total market index is just a small blip on the radar compared to the massive movements of the top 500.
However, there are subtle differences:
- Small-Cap Effect: Historically, small-cap stocks have been more volatile but have also offered periods of higher growth. A total stock market fund gives you exposure to this. When small-caps are outperforming large-caps, the total market fund will slightly outperform the S&P 500 fund (and vice-versa).
- Risk: The S&P 500 is slightly less volatile because it excludes the smaller, riskier companies. The total stock market takes on a tiny bit more risk by including them.
For most long-term investors, these performance divergences are minor and tend to even out over time.
So, Which One Should You Choose?
Here’s the answer that most experts (and seasoned investors) will give you: You can’t go wrong with either one. This is not a decision that will make or break your financial future. The most important thing is that you are investing consistently in a low-cost, diversified U.S. stock fund.
That said, here’s a simple way to think about it:
Choose the S&P 500 if:
- You prefer simplicity and want to own the 500 most dominant U.S. companies.
- You believe the biggest companies will continue to lead the market.
- You want a fund that is sometimes available with an infinitesimally lower expense ratio.
Choose the Total Stock Market if:
- You want the absolute maximum diversification possible.
- You don’t want to miss out on the next potential Google or Amazon, which might start as a small-cap company.
- You are a purist who wants to own a piece of the entire market, not just the biggest slice of it.
The Final Word
The debate between S&P 500 and Total Stock Market is a classic, but it's often a distinction without a major difference for the average investor. Think of it as choosing between a fantastic pizza and a fantastic pizza with a couple of extra toppings. Both will satisfy your hunger and are great choices.
Don’t let this decision paralyze you. The real risk isn't choosing the "wrong" index fund—it's sitting on the sidelines and not investing at all.
Pick one, invest regularly, and let compound interest do the heavy lifting for your future. You'll be glad you did.