Which ETF belongs in your portfolio?

If you are just starting out, it makes total sense to invest in the entire US market. You’ve got exposure to stocks and diversification all in one package. Except, how does one do that?


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SPDR S&P 500, aka SPY, is the most traded ETF by volume and if you own it, you are basically invested in the entire US market. That’s because SPY tracks, or attempts to recreate the performance of the S&P 500, which itself is an agglomeration of the biggest 500 stocks in the US financial market.

VFINX is Vanguard’s first index mutual fund. It started way back in 1976 and it also invests in such a way as to track the S&P 500. It’s got the pedigree, it’s got the history and to round out the bunch, we’re also going to look at the iShares Core S&P 500 – which also follows the S&P 500.

Given these three very similar choices, which one should you go for?

It’s hard to separate one from the other. In theory, they should all be the same as they are tracking the same index but as we all know, the devil is in the details.

Learn About Expense Ratios

Let’s look at their expense ratios to start. They all have expense ratios than are very affordable.  The expense ratio is important because it’s the fee you pay for owning the fund. The lower the expense ratio, the more money you make in the long run.

The average mutual fund has fees between 1.25% and 1.5%. Here’s what you can expect from our contenders.

expense_ratios

The chart above really crystallizes the choice for the investor who needs to pull the trigger. While all the expense ratios are very low, iShares really stands out with an expense ratio of just 0.04%.

If that weren’t enough, the iShares ETF also has the best dividend yield of the three contenders, at 1.83%.

On the weight of the numbers alone, you should probably go for the iShares Core S&P 500 (IVV).

However, you should consider a few other factors because making the final decision. The iShares fund is also different in that it uses derivatives, portfolio lending and other relatively riskier strategies than SPY or VFINX. There’s a little more risk, but potentially also more reward.

The final consideration is that SPY does not immediately reinvest its dividends like iShares. Instead, SPY holds the dividend as cash for a while. With immediate reinvestment, your money has longer to marinate – so to speak.

What about performance?

You might think that SPY, VFINX and IVV would all have the exact same performance as the S&P 500 but it makes sense that it would actually do slightly worse. That’s because these funds have to buy and sell stocks to keep their internal ratios accurate while the S&P 500 is this ideal, frictionless, trading-fee less portfolio.

spy-vfinx-s&p500

Rebased to 100; Jan 2001; source: Google Finance

So really not much to choose from there. Theoretically you can expect each one of these indexes to underperform the S&P 500 by their expense ratios, since that’s the cut that the company is taking versus the S&P 500.

The one ETF that needs to be in your portfolio?

Congratulations, it’s the iShares Core S&P 500.

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