Total Market Offers Simplicity and Clarity

Wednesday, March 11, 2009

Total market ETFs are simple tools but bring subtle benefit beyond mere convenience. They allow the investor to see the forest and not just the trees.

2008 and 2009 tested the patience of buy-and-hold investors who form the core constituency for total market. Few asset classes avoided damage, however, so total market investors would have gained little by trying to pick among industrial sectors or countries. One had to be largely in cash to avoid calamity. And here total market's simplicity helped focus the most important question of recent times: should one be in or out of the market?

For total market investors this question comes naturally. They are not distracted by details of growth vs. value, REITs, commodities, China and the myriad of other asset classes found in many portfolios. Total market is criticized for oversimplifying, but often simple concepts are more insightful.

In practice, total market often mirrors US large cap so the difference is modest:

For American investors the total market is commonly defined as the universe of publicly traded US stocks weighted by capitalization. Typically it anchors simple buy-and-hold portfolios, but excellent liquidity helps more active investors rotate in and out of economic cycles efficiently. We include in this report ETFs which track stocks around the world as well as ETFs which add exposure to the total US bond market.

It might seem daunting to own thousands of stocks, but most ETFs use a sampling methodology to track their index. This avoids having to buy small, illiquid stocks precise amounts. Often the ETFs buy or sell index futures as well to handle money inflows and outflows.

Cost conscious investors love total market funds. Annual management expenses tend to be low. Very broad indexes by nature have but one boundary at the very bottom of market capitalization, so turnover costs are low. Also arbitrageurs have little opportunity to time attacks on indexes prior to component additions or deletions as they do with an index such as the S&P 500.

Among total market or associated ETFs are:

Basic low-cost US

Vanguard Total Stock Market ETF (AMEX:VTI; annual fees: 0.07%

SPDR Dow Jones Wilshire Total Market ETF (NYSEArca:TMW); annual fees: 0.2%

iShares Russell 3000 ETF (NYSEArca:IWV); annual fees: 0.2%

VTI uses the MSCI US Broad Market Index with about 3,800 stocks, while TMW follows the Wilshire 5000 which is one of the most comprehensive index available with more than 5,000 US stocks, and IWV tracks the Russell 3,000 with over 3,000 US stocks. The broader indexes include more small companies and therefore tend to have improvd diversification, lower average market cap, higher average growth rates, and higher risk, all in modest amounts.

Fundamental

ELEMENTS Benjamin Graham Total Market Value Total Return ETN (NYSEArca:BVT), annual fees: 0.75%; selects 100 firms using valuation techniques developed by Benjamin Graham, the father of fundamental investing.

Style

iShares Russell 3000 Growth ETF (NYSEArca:IWZ), annual fees: 0.25%; carves off about 1,800 stocks in the Russell 3000 which have higher projected growth and higher price-to-book ratios.

iShares Russell 3000 Value ETF (NYSEArca:IWW), annual fees: 0.25%; is the complementary inverse of IWZ

Global/International

Vanguard Total World Stock ETF (NYSEArca:VT), annual fees: 0.25%; tracks the FTSE All-World Index of about 2,900 stocks in 47 countries, including about 44% holdings in the US

SPDR MSCI ACWI ex-US ETF (NYSEArca:CWI); annual fees: 0.35%; targets the world's publicly traded companies outside the US and thus complementary to a US total market fund

SPDR S&P World ex-US ETF (NYSEArca:GWL); annual fees: 0.35%; very similar to CWI, this global (except US) total stock fund sports slightly higher average market caps

Balanced

PowerShares Autonomic Balanced NFA Global Asset Portfolio ETF (AMEX:PCA), annual fees: 0.25%; this fund of funds containts numerous PowerShareses, iShares and Vanguard ETFs resulting in a traditional portfolio of 60% stocks and 40% bonds a majority of US-based assets.

Claymore U.S.-1-The Capital Markets ETF (AMEX:UEM), annual fees: 0.55%, contains exposure to 2,000 US stocks and fixed income of every stripe, including government and quasi-government bonds like Fannie Mae.

Lifecycle

XShares offers a line of total stock and bond funds which change over time. They start with relatively high US equity allocations and glide down to 10% on their target date listed in their title, and then they increase their equity allocation until it reaches 33% where it stays put. TDX had a target date of 2007 and thus is moving up to its final 33% equity allocation.

XShares TDX Independence 2010 ETF; (NYSEArca:TDD); annual fees 0.73%

XShares TDX Independence 2020 ETF; (NYSEArca:TDH); annual fees 0.73%

XShares TDX Independence 2030 ETF; (NYSEArca:TDN); annual fees 0.73%

XShares TDX Independence 2040 ETF; (NYSEArca:TDV); annual fees 0.73%

XShares TDX Independence In-Target ETF; (NYSEArca:TDX); annual fees 0.73%

Co-founder of indexfunds.com, author of two books on investing, and founder of ETFzone.com, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.