This 16% Difference Could Make the Vanguard Total Stock Market ETF Outperform the S&P 500 During a Stock Market Sell-Off

There are many different ways to quantify the broader stock market.

Indexes like the S&P 500 (SNPINDEX: ^GSPC), Nasdaq Composite (NASDAQINDEX: ^IXIC), Dow Jones Industrial Average (DJINDICES: ^DJI), or Russell 2000 offer measurable ways to analyze stock market performance. Each has its pros and cons, but the S&P 500 is arguably the most commonly used benchmark. Even famed investor Warren Buffett has often said that an S&P 500 index fund is a great tool for compounding wealth over time for folks who don't want to follow markets closely.

The general theme in the U.S. stock market for several years now is that the largest companies, especially tech-focused companies, have been contributing the bulk of market gains. And while the S&P 500 used to make up around 75% to 80% of total U.S. market capitalization, it is now 84% according to Sept. 30 data from Siblis Research. That leaves 16% for the smaller mid-cap, small-cap, and micro-cap stocks that aren't in the S&P 500.

The U.S. stock market is now so concentrated that the two most valuable U.S. companies by market cap -- Nvidia and Microsoft -- have a combined value roughly equal to the 3,000 or so companies that aren't in the S&P 500 and have a market cap over $250 million.

Investment management firm Vanguard offers some of the lowest-cost and biggest exchange-traded funds (ETFs) and index funds by net assets -- including the ultra-popular Vanguard S&P 500 ETF (NYSEMKT: VOO). But it may surprise you to learn that the Vanguard Total Stock Market ETF (NYSEMKT: VTI) is actually the biggest publicly traded fund in the world with over $2 trillion in net assets.

Here's a key difference between the two funds that could make the Total Stock Market fund a better choice than the Vanguard S&P 500 ETF.

Image source: Getty Images.

More diversification for the same low expense ratio

Both funds have expense ratios of 0.03% or just $3 for every $10,000 invested -- which is the lowest expense ratio offered by any ETF or index fund. They also both have 1.1% 30-day SEC dividend yields.

The S&P 500 ETF has 504 holdings compared to 3,529 for the Total Stock Market ETF. Therefore, the Total Stock Market ETF will have slightly lower weightings across all S&P 500 components, because its assets are also spread among smaller stocks as well. The bigger the market cap of the individual stock, the larger the difference in the allocation between the two ETFs.

Data source: Vanguard. https://investor.vanguard.com/investment-products/etfs/profile/voo#portfolio-composition and https://investor.vanguard.com/investment-products/etfs/profile/vti#portfolio-composition

As you can see in the table, the Vanguard S&P 500 ETF is noticeably more concentrated in the largest companies by market cap. It's not a big difference, but the added diversification of the Total Stock Market ETF could help it outperform the S&P 500 during a stock market sell-off -- especially if that sell-off is driven by a slowdown in artificial intelligence (AI) spending.

The S&P 500 ETF has 44.9% of its holdings in tech and communications stocks, whereas the Total Stock Market ETF is just 39.9%. The Total Stock Market ETF also has less exposure to financials and higher weightings in cyclical sectors like consumer discretionary and industrials, which could make it a coiled spring for a recovery in consumer spending.

Let ETFs work for you

Index-based and total-market funds are great plug-and-play choices for buy-and-hold investors seeking simple, low-cost exposure to hundreds or even thousands of stocks. The differences between the Vanguard S&P 500 ETF and the Total Stock Market ETF are subtle, but they do matter for long-term investors looking for a position they can steadily add to for years or even decades.

A good approach is to use ETFs to fill a need in your portfolio. For example, if you have a sizable position in a stock like Nvidia and are looking for a general market ETF for diversification, then the Total Stock Market ETF's slightly lower exposure to S&P 500 companies may be a better fit. Conversely, if many of your major stock holdings aren't megacap companies, then a top-heavy fund like the Vanguard S&P 500 ETF or even the Vanguard Mega Cap ETF, Vanguard Mega Cap Growth ETF, or Vanguard Mega Cap Value ETF could be excellent choices.

The key takeaway is that, in today's era of ultra-low-cost ETFs and index funds, investors should be selective and choose funds that best align with their risk tolerance and investment goals. An S&P 500 ETF provides a good starting point and a baseline for comparing other funds. But there are better options depending on your portfolio's needs.

JPMorgan Chase is an advertising partner of Motley Fool Money. Daniel Foelber has positions in Nvidia and Vanguard Total Stock Market ETF. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Berkshire Hathaway, JPMorgan Chase, Meta Platforms, Microsoft, Nvidia, Tesla, Vanguard S&P 500 ETF, and Vanguard Total Stock Market ETF. The Motley Fool recommends Broadcom and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.