The heavyweight fight Wall Street doesn’t want you to know about…
This should be a Pay Per View fight.
But Wall Street would rather you never know about it!
But we are going to do it anyway!
Let’s meet our fighters…
The S&P 500 Index ETF…$SPY Index Fund
The S&P 500, the big daddy of them all, the largest basket of 500 non Dow Jones Industrial Average stocks.
The S&P 500 is the one index that every professional trader looks at every day…
Ladies and gentlemen, in the red corner, let me introduce you to the $SPY, the S&P 500 index ETF that trades 1/10 the size of the S&P 500 index.
Highlights of the SPY index fund include:
- The King of Liquidity
- Averages over 100,000,000 shares traded per day
- Averages over 2,500,000 options contracts traded per day
And now for the challenger…
Vanguard 500 Index Fund Investors Share…$VFINX
Ladies and gentlemen, in the blue corner, let me introduce you to the $VFINX, Vanguard’s low cost index fund.
Rather than me talk about this index fund, let’s hear it from the horses mouth:
As the industry’s first index fund for individual investors, the 500 Index Fund is a low cost way to gain diversified exposure to the U.S. equity market. The fund invests in 500 of the largest U.S. companies, which span many different industries and account for about three-fourths of the U.S. stock market’s value. The key risk for the fund is the volatility that comes with its full exposure to the stock market. Because the 500 Index Fund is broadly diversified within the large-capitalization market, it may be considered a core equity holding in a portfolio.
- $242.4 billion dollars under management
- 0.16% expense ratio
- Warren Buffet approved low cost index fund
In fact, here is Greenline 401k giving a presentation on Buffet’s feelings on low cost index funds:
Did you catch that?
If you watched the video or not, there is something I need you to take away here…
Warren Buffet is quoted as saying:
Don’t listen to Mutual Fund Advisors and Mega Fund managers, they mathematically cannot beat the market by charging fees
While that may be true as mutual funds and hedge funds do charge large fees, we will attempt in the rest of this article to see if we can “mathematically” prove if a low cost index fund is better than your everyday index ETF that anyone can buy.
Round 1: Portfolio Composition
For starters, it appears that $VFINX’s index fund version (left) and the $SPY index fund (right) have the same allocation to the T.
I don’t know if one copied the other or they both copied each other.
But they have an identical breakdown of percent allocation to different sectors.
After round 1 here are the scores:
Round 2: Expense Ratio
What is that?
An expense ratio is the amount (percentage) of the total assets under management that are taken out each year to pay administrative fees (salary’s, back office, accounting, etc).
Or in lesser terms…
The amount taken out each year to pay operational expenses for managing the fund.
Let’s see what our fighters looks like here in round 2…
According to Vanguard, $VFINX as of 4/27/2016 has an expense ratio of 0.16%.
According to State Street Global Advisors, the $SPY index fund has an expense ratio of 0.11%.
While it looks like a small margin of victory, round 2 is a victory for the $SPY index fund.
After round 2 here are the scores:
Round 3: Dividend
Ah the dividend…
Let’s just get to it shall we?
Drum roll please…
According to YCharts.com…
Small win again for the $SPY index fund.
After round 3 here are the scores:
Round 4: Barrier to Entry
How much money do I need to pay the toll?
How much money do I need to play the game?
How much money do I need to invest in one of these guys?
Of course we have the answers for you 🙂 :
According to our friend (or maybe former friend) Vanguard, here is the initial investment size needed for $VFINX:
According to anyone not living under a rock, the initial investment size needed for the $SPY index fund is equivalent to one share of it’s stock (as of 9/21/2016):
Looks like the is becoming a very one sided bout:
After round 4 here are the scores:
Round 5: Ability to Get in and Out
Can I buy or sell whenever I want?
If the market is tanking, can I buy?
If the market is shooting higher, can I sell and book profits?
Let’s find out…
For starters, we know with the $SPY index fund, you can get in and out whenever you want any time throughout the trading day.
But what about for our dear friend $VFINX…
According to Investopedia:
An investor can redeem fractions or whole shares of a mutual fund by selling them at the NAV. When will the redemption price be determined? At the same time that the fund company computes the daily NAV for the fund and determines at what price investors purchased shares after the close of trading yesterday or before the close of trading today, or 4pm.
The above explanation filled with buzzwords simply means…
No, you can only get in and out of $VFINX when the price (NAV) is calculate at the end of the day (4pm)
In this scenario, no matter what happens, you are at the mercy of whatever the NAV (price) ends up being at the end of the trading day 🙂
If you want to buy in the morning because you think the market will go higher…
Another win for the $SPY index fund here…
Round 6: Annual Performance
Fortunately for us, we don’t have to do any number crunching here as our friends from Vanguard are nice enough to give us the chart right on their website.
Strangely however, they are displaying this information to the public that clearly shows $VFINX in the blue lagging the $SPY in the yellow.
Not by a lot…
But with identical asset allocation…
It appears that the $SPY index fund has returned more when compared to $VFINX.
NOTE: $SPY’s inception date is 1/22/1993 so they do not have statistics going back to 1976.
Ummmmm…SPY Index Fund?
What is going on here? I don’t understand? I thought “low cost index funds” were the way to go…
Let me break it down for you my friends…
The goal the these “low cost index funds” is to gather assets and charge fees.
And because that is their business model…
They spend hundreds of millions of dollars a year marketing to you…
To try to convince you to give them your money because is it “cheaper” than doing it yourself…
And it is “impossible to beat the market”…
And we just mathematically proved why anyone can mathematically beat a “low cost index fund” (thanks Mr. Buffet) 🙂
Fortunately for Vanguard, there are many other advantages to opening up your own low commission brokerage account that are not quantifiable:
- While $SPY trades over 2.5 million contracts a day, $VFINX does not, making it is not possible to compare hedging strategies between the two
- While $SPY trades over 100 million shares a day, $VFINX does not publicly disclose that information, making it not possible to compare the distance between the bid and the ask (what someone is willing to buy and sell at)
- While $SPY trades over 100 million shares a day, $VFINX does not publicly disclose that information, making it not possible to compare the ease of getting in and out of $VFINX at whatever price you want
So what am I saying here?
I am saying that together we just proved that $SPY is cheaper and returns more money than $VFINX.
I am saying that if you buy this “low cost index fund” then yes, it is impossible to beat the market.
I am saying that “low cost index funds” are not the best options for individual investors who want a “diversified” return.
I am saying that while Wall Street spends hundreds of millions of dollars on marketing a safer and more diversified option…
It is mathematically impossible for you to make more money giving your money to Vanguard and having them invest in $VFINX for you when compared to opening up a brokerage account and buying $SPY yourself.