A total market index fund is a type of mutual fund. Mutual funds are investment vehicles that allow you to easily diversify your investment across various investment securities¹. For example, a mutual fund may contain 200 different stocks and 20 different bonds. A total market index fund usually has at least 80% of its portfolio in domestic U.S. stocks and can hold as many as 3,000 different stocks. Generally speaking, total market index funds track the U.S. economy because it essentially invests in nearly all the U.S. stocks on the major exchanges.
The total market index funds that many of our friends currently own include Schwab Total Market Index Fund (SWTSX)², Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX)³, and Fidelity® Total Market Index Fund Investor Class (FSTMX)⁴. A quick disclaimer: at the time of publishing this blog post, we are not sponsored by Charles Schwab, Vanguard, or Fidelity. We are merely speaking from my own experiences with these funds.
Above is the a chart of the 3 funds’ performance from 2001 to 2018 including the 2 recessions (Dot-com Bubble⁵ and Housing Bubble⁶) that occurred.
These total market funds satisfy all 3 rules from our investment philosophy to maximize returns in the financial markets:
- Indexes representing the U.S. economy historically increase over time
- Buying and holding securities is better than timing the market
- High cost, actively managed funds rarely beat low cost, passively managed funds
Notice how the historical returns follow the U.S. economy in the chart above. The returns dip during the recessions in 2001 and 2007, then increase at a much higher rate after recovering from the recessions.
We, as investors, should be aware of how to minimize costs as much as possible. Luckily for us, the 3 total market index funds above do not have trading commission costs when purchased or sold on their respective platforms. Currently, the 3 funds have low expense ratios of 0.04% or less. A quick explanation on how expense ratios work - these are annual fees charged to investors. For example, if you invested $10,000 in VTSAX by the end of the year, you would be charged $4. These low expense ratios of 0.04% or less are normal for passively managed funds. On the other hand, the standard for actively managed funds is 1%; with $10,000, you will be charged $100. That’s a big difference in cost!
Let’s walk through a simple example together. In 2000, Amy just graduated college and found her first full time job with a 401(k). Like many other college graduates at her age, she has no clue about how to invest for retirement. All she knows is the earlier she invests for retirement, the better. Amy stumbles upon our blog about investing in total market index funds and begins doing her own research to understand what a 401(k) is and its advantages. Luckily for her, Amy’s employer’s 401(k) offers SWTSX. She begins to contribute a part of her paycheck to her 401(k) and purchases only SWTSX. After a year of contributing, her 401(k) is worth $5,000. At this point, the Dot-com Bubble just burst and the recession has began, SWTSX is worth $19.98⁷ per share. Amy remembers the 3 rules and that the U.S. economy will eventually recover, and so will SWTSX. For the sake of simple calculations, let’s assume Amy doesn’t contribute more money to her 401(k) and leaves it at $5,000. Fast forward to the beginning of 2018, the U.S. economy experienced one additional recession and has now recovered. SWTSX is worth an astonishing $48.42⁷ per share, which is a 142.34% increase! In 18 years, Amy’s $5,000 grew to roughly $12,117. We say roughly because SWTSX has a low expense ratio and pays dividends, so it’s difficult to calculate an exact return. Keep in mind for simple calculations, we are assuming Amy is contributing to her 401(k) for only the first year. Normally investors should contribute each year up until retirement. In other words, Amy’s returns would be much higher!
Just like Amy, we have invested in total market funds and over 90% of our investment portfolio are the total market funds mentioned above. Interested in our allocation? We will share more on this in a later post!
Got questions about a total market index fund? Let us know, we are always happy to discuss in the comments below!
¹ Read more about mutual funds here
² Read more about Schwab Total Market Index Fund (SWTSX) here
³ Read more about Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) here
⁴ Read more about Fidelity® Total Market Index Fund Investor Class (FSTMX) here
⁵ Read more about the Dot-com Bubble here
⁶ Read more about the Housing Bubble here
⁷ Historical Price Data for SWTSX can be found here
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