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The Short Answer

Is One ETF Enough?

When building a portfolio using broadly diversified ETFs from Vanguard or other shops, consider costs and allocation.

Question: I want to use Vanguard index funds for U.S.-stock exposure and am trying to decide between investing in  Vanguard Total Stock Market ETF (VTI) or a combination of the  Vanguard S&P 500 ETF (VOO) and  Vanguard Extended Market Index ETF (VXF). I know the first one is cheaper, but are there any downsides to using that alone?

Answer: The broadly diversified domestic-stock exchange-traded fund, Vanguard Total Stock Market ETF, and its mutual fund sibling,  Vanguard Total Stock Market Index (VTSMX), hold an undeniable appeal that have helped them collectively grow into the biggest funds in the world, with more than $300 billion in assets. Their low expense ratios, exposure to virtually all publicly traded U.S. stocks, and well-regarded parent company make them the default choice for many investors.

As you point out, using Vanguard Total Stock Market ETF alone does provide a cost advantage versus dividing your investment between Vanguard S&P 500 ETF and Vanguard Extended Market Index ETF (referred to hereafter by their ticker symbols). VTI costs just 5 basis points, or 0.05% of assets, while VOO and VXF--an ETF that invests in 500 of the largest U.S. companies and a complementary ETF that provides exposure to most of the other U.S. companies--cost 5 and 10 basis points, respectively. So how significant is this cost difference? Probably not as much as you might think.

Comparing Costs
As an example, let's say you had a $100,000 portfolio you wanted to invest in U.S. stocks and you put the entire amount in VTI. In that case you'd pay $50 in annual expenses to own the ETF (in case you hadn't already figured it out, 0.05% is a really, really small number). Now suppose you decided to divide your holdings, putting 75% into VOO and the other 25% into VXF. In that case you'd pay $37.50 per year for the assets held in VOO ($75,000 x 0.0005) and $25 per year for the assets held in VXF ($25,000 x 0.001) for a total of $62.50, or $12.50 more than you'd pay by putting all the assets in VOO. Chances are that if you have a portfolio worth $100,000, saving an extra $12.50 per year by choosing VTI over the alternatives isn't going to make or break you, so the question essentially becomes a wash.

An investor could consider a similar strategy using ETFs from  Charles Schwab (SCHW); these funds are comparable in cost and constituents to the aforementioned Vanguard ETFs.  Schwab U.S. Broad Market ETF (SCHB) (which holds the largest 2,500 stocks as opposed to the 3,700 or so held by VTI) and  Schwab U.S. Large-Cap ETF (SCHX) (which holds the largest 750 U.S. stocks versus 500 for VOO) each charge just 4 basis points annually.  Schwab U.S. Mid-Cap ETF (SCHM) and  Schwab U.S. Small-Cap ETF (SCHA), which may be added as complementary portfolio holdings to SCHX to provide exposure to stocks that SCHX doesn't own, cost 7 and 8 basis points, respectively. One note: Building a portfolio using a mix of these Vanguard and Schwab ETFs could result in overlapping holdings, so it's usually best to stick with one ETF family or the other. Another option would be to use Vanguard, Schwab, or Fidelity index mutual funds to achieve your goals.

The Real Issue Is Allocation
However, the more relevant issue here is one of allocation. By putting all your assets in VTI, which, like the other ETFs mentioned here, weights holdings based on their market capitalizations, you are basically locking yourself into how the market as a whole values the thousands of companies the ETF owns. If you're an indexing purist, this might be just what you want, making a broad market ETF the perfect choice. That said, if you want more control over your asset allocation a (slightly) more complex portfolio may be in order.

For example, VTI currently holds about 72% of its assets in large-company stocks, with another 19% in midsized companies and the remaining 9% in small-company stocks. But what if you think mid- and small caps are likely to outperform large-company stocks over the long haul and want more exposure to them? Owning the S&P 500 and extended-market ETFs separately gives you more control over your own personal allocation, and this can be done with just the two ETFs or with more depending on how much allocation control you want. (As a baseline, the S&P 500 represents about three fourths the value of the U.S. stock market, so a portfolio of 75% VOO and 25% VXF would approximate the total market allocation of VTI.) You could even use VTI as a core holding and add additional mid- and small-cap exposure by holding a percentage of assets in VXF, as well. Just be careful when dealing with overlapping holdings that you don't unintentionally overweight certain stocks or sectors as you go.

The main takeaway is that a total stock market ETF or mutual fund such as VTI is dirt-cheap and a great way for many investors to gain broad market exposure in an easy-to-own package. But if you want a little more control over your portfolio, you'll probably have to pay a little more and spend a little more time managing your portfolio by owning multiple ETFs or mutual funds.

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