"Total Stock Market" Index Funds
A New Fad or Investment Nirvana?

Jeff Troutner, TAM Asset Management, Inc.

A new investment trend has emerged, fueled by recent stock market performance and given substantial creditability by none other than John Bogle, the Chairman of the Vanguard Group. The trend is toward investing in "total market" index funds rather than a diversified-sometimes tilted-blend of large, small, growth, and value stocks. It is a simple, foolproof, low cost strategy that can't fail, according to its most vocal promoters.

The current popularity of these funds is due primarily to investor perception that they offer much more exposure to small company and value stocks than the S&P 500 funds. If true, this would eliminate the need to "slice and dice" a portfolio among various asset classes to increase diversification while also increasing expected returns. It would also eliminate the need to ever change your portfolio strategy. One-stop shopping, in essence.

Ah, life (and investing) should be so simple! Unfortunately, the total market approach is based on two flawed premises: One, that total market index funds actually represent the total market of stocks, and two, that investors will stick with the strategy for any length of time.

Let's look at the first premise. A total market index fund is usually based on the very broad Wilshire 5000 index. The Vanguard Total Stock Market index fund is the leader in the category and owns about 3200 stocks weighted by market cap (3200 stocks is considered a good enough sample of the over 7000 stocks actually in the index). The 3200 are not equally weighted, so the largest companies make up the largest percentage of the index. As a result, the 100 largest companies, or about 3% of the total, represent almost 60% of the total value of the Vanguard fund!
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