Better Buy: Vanguard Total Stock Market ETF vs. SPDR Portfolio S&P 1500 ETF

When most investors think about buying "the market," they probably have the S&P 500 index (SNPINDEX: ^GSPC) in mind. But that's not the market -- it's just 500 or so hand-selected large and economically representative companies. If you want to own the market, you'll have to consider an exchange-traded fund (ETF) like the Vanguard Total Stock Market ETF (NYSEMKT: VTI) or the SPDR Portfolio S&P 1500 ETF (NYSEMKT: SPTM). They are not interchangeable, and in the end, one may be even better than the S&P 500 index.

The best way to buy "the market"

It would be virtually impossible for most investors to go out and buy 500 stocks, let alone 1,500 or 3,598 (more on this strangely precise number in a second). So the only real option for buying the market is to buy a pooled investment vehicle like a mutual fund or an ETF. Given the many benefits of exchange-traded funds, including ultra-low costs and all-day trading, ETFs are likely to be the go-to option.

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Image source: Getty Images.

But when you are looking to buy "the market," you have to actually decide what that means. The S&P 500 index is a good starting point, but it is a list of roughly 500 companies that have been selected by a committee to be representative of the U.S. economy. The stocks in this index, which can be bought via the Vanguard S&P 500 ETF (NYSEMKT: VOO), make up around 80% of the market cap of all U.S. stocks. That's a lot of the market, but it isn't all of the market.

The rest of the market is largely made up of small and medium-sized companies. However, there will also be large companies that didn't make it past the committee process for some reason, which often includes financial troubles of some sort. But all of these companies add diversification for investors who truly want to own "the market." This is where the Vanguard Total Stock Market ETF and the SPDR Portfolio S&P 1500 ETF come in.

Extending the theme and just buying it all

The SPDR Portfolio S&P 1500 ETF is basically a cousin to the S&P 500 index. It owns the S&P 500, plus the S&P MidCap 400 Index and the S&P SmallCap 600 Index. Add it all up, and you get roughly 1,500 stocks that account for around 90% of the market cap of all U.S. stocks. All three of these indexes follow the same basic committee approach, though the S&P 500 gets the most scrutiny.

Still, that's not all of the market. The Vanguard Total Stock Market ETF gets you much closer, with 3,598 holdings. That said, there's no screening process here other than the stock being traded on a U.S. exchange. Like the S&P options, the Vanguard Total Stock Market ETF is market cap weighted, so the largest stocks have the most effect on the ETF's performance. However, adding in those extra 2,000 or stocks has made a big difference on the performance front.

SPTM Total Return Price data by YCharts.

As the total return chart above highlights, the Vanguard Total Stock Market ETF has outperformed both the S&P 500 index and the S&P 1500 index over the longer term. In other words, when you buy the market, all of those extra stocks -- around 20% of the overall market cap of the U.S. market -- appear to add value. Notably, cherry-picking stocks with a committee doesn't appear to help all that much.

If you want "the market," think bigger

If you say you own the market and you only own the S&P 500 index, you don't actually own the market. If history is any guide, owning as much of the market as possible appears to have a performance benefit. That's why index investors should probably take a closer look at the Vanguard Total Stock Market ETF. You may decide to stick with the S&P 500 and its committee approach, but you should at least look at your other, and possibly more attractive, options.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF and Vanguard Total Stock Market ETF. The Motley Fool has a disclosure policy.