The FIRE community, countless economists, Bogleheads, and Biglaw Investor all know the value of index investing. If you want to use Vanguard (and there are many reasons to do so) to buy total stock market index funds, you have two popular options: VTSAX (mutual fund) and VTI (ETF). Here’s how to decide between the two.
Why invest in total stock market index funds?
The reason for index funds is built on sound principles. Briefly explained, stocks go up and down, but generally tend to go up over time. However, because of the efficient market hypothesis and various behavioral tendencies, individual (retail) investors tend to lose money despite the overall market trending upwards; it is simply not a reliable strategy for investors to try to pick the winners and avoid the losers.
Diversification is the antidote to the efficient market hypothesis. If you pick 10 stocks rather than 1, some will go up and some will go down, but you can expect more gains than losses overall, especially over a longer period of time. The winners will weather the losses of your losers, and each stock will usually win more overall over time. In order to ensure that you catch the overall upwards trend, you may have to pick 10, 50, or 500+ publicly traded companies. Here, the logical conclusion is to invest in the entire stock market at once; to own a piece of every single publicly traded company’s success.
Non-stock or foreign investments further diversify your portfolio, but in terms of U.S. stocks, the total stock market is the end game (note: diversification has diminishing returns, so the S&P 500 index will provide very similar results to the total stock market index).
Even a large company that takes up a significant weight of the index fund could fail, but unless the U.S. economy fails entirely, a new company – one that you already own a piece of – will grow to take its place. Because index funds rebalance on their own, the largest and most profitable stocks will be prioritized, and you can rest easy knowing that you are riding the market. With the average individual investor losing money and the average index fund historically returning ~8%, there are few reasons to not invest using index funds. Less stress, less mess, and it’s also a fairly tax efficient investment strategy.
The Mutual Fund: VTSAX
VTSAX, or the Vanguard Total Stock Market Index Fund Admiral Shares, is a mutual fund. Mutual funds are often actively managed, but in the case of VTSAX, it is indexed (rebalances based on the market), so there is no fund manager actively making decisions with your money on a day-to-day basis. Mutual fund orders are executed once at the end of the day, so all of the money invested throughout the day will be used to purchase the index at the same cost for every investor.
VTSAX’s expense ratio is 0.04% (as of 04/29/2021). VTSAX also requires a minimum investment of $3,000. Investments can be added automatically into the fund, so VTSAX works well for the “set it and forget it” strategy. VTSAX can be purchased in increments down to the cent after the minimum amount, so you can invest any amount such as exactly $500.50 per month. In order to purchase VTSAX, you will need to use Vanguard. Other brokerages will likely have their own version of VTSAX (e.g. FZROX for Fidelity, SWTSX for Schwab) but they may differ with minimum investments or expense ratios.
- Minimum investment: $3,000
- Investing unit: Any amount
- Expense ratio: 0.04%
- Trading period: Add money any time, purchased once at the end of the trading day
- Pricing: Calculated once per day
- Automatic investing: Yes
- Brokerage required: Vanguard only
The ETF: VTI
VTI, or the Vanguard Total Stock Market Exchange-Traded Fund, is an exchange-traded fund (ETF). ETFs are usually passively managed, and they are traded much like any other stock on the market. ETFs experience price changes throughout the trading day, which means that you get the price of the ETF at the moment you purchase the ETF.
VTI’s expense ratio is 0.03% (as of 04/29/2021) so it is (negligibly) less costly than VTSAX’s expense ratio. There is no minimum investment except for the purchase price of a single share to start, so it is a good option for people who might not have the cash to invest $3,000 at once. VTI cannot be invested by the whole dollar, and you must invest in increments of the whole price of the ETF at the time of purchase. VTI, like most ETFs, can be purchased even if you are not using Vanguard as your brokerage.
- Minimum investment: Price of one share
- Investing unit: One whole share
- Expense ratio: 0.03%
- Trading period: Anytime during open market hours
- Pricing: Real-time during open market
- Automatic investing: No
- Brokerage required: Any brokerage
So which do I pick?
Any index investor will be splitting hairs when choosing between VTSAX or VTI. Because the two track the same index (here, the entire U.S. stock market), your return on investment will be essentially the same. You are still getting Vanguard’s rock bottom expense ratios and the 0.01% difference will hardly ever be noticeable. There are some reasons to distinguish the two though, and it mostly depends on your personal investing preferences.
VTSAX will allow automatic purchases and you can make these purchases outside of market hours. VTI on the other hand will require you to trade during the day. With this comes the slight advantage of being able to jump in and out of the market. However, few index investors will have reason to “day trade” the entire stock market because there isn’t enough volatility to reward such an effort.
VTI can be purchased from any brokerage account. If you are already using another brokerage, it may not be worth the hassle to open a Vanguard account just to access a Vanguard fund like VTSAX. Other brokerages usually have their own similar mutual fund too, so it isn’t like your investment portfolio is entirely crippled as a result of not using Vanguard.
New investors who can’t commit $3,000 at once can begin investing with a single VTI purchase. At this very moment, VTI is sitting around $240, so even if it goes up or down significantly, VTI will still be much more accessible to new investors than VTSAX. Once you have purchased enough VTI over time to amass at least $3,000, you can then choose to sell VTI and purchase VTSAX instead.
VTSAX, unlike VTI, can be invested in using nice round whole-dollar amounts. $500 of VTSAX can always be invested in full, but if VTI costs $251, then you can only buy one share while the other $249 needs to sit around until you can purchase another whole share. VTSAX permits investors to measure using dollars instead of shares.
Finally, some psychological benefits can be at play here. VTSAX will help investors avoid constantly checking the market. If you think you might be tempted to exit the market on a bad day or purchase more than you should on a good day, then VTSAX can take away those temptations. However, VTI on the other hand can offer more control to the investor. Manually purchasing ETFs can serve as a good reminder of your efforts towards your financial goals, and some people enjoy engaging with their investments rather than trying to let it run in the background quietly.
Joseph Kim is a 3L at Notre Dame Law School. Joseph grew up in California where he developed an interest in working with music, powerlifting, and bowling. He’s been a member of the FIRE community since before law school and plans to pursue FatFIRE following graduation.
I like the analysis. The requirement to buy whole shares of ETFs doesn’t really factor into my analysis because so many brokerages today allow you to purchase fractional shares. And the mutual fund mental benefit of not worrying about timing the market can be mostly replicated with ETFs if you stick to a strict investing schedule or use an automated service like M1 Finance. Because ETFs do a better job of deferring capital gains taxes, that’s what I personally opt for. Although for investments held in a tax-favored accounts the tax difference doesn’t matter.
I agree it is a little misleading because fractional shares are available at most brokerages. Also VTSAX had an adverse tax surprise a few months ago.