S&P 500 or US Total Market ETF? The Better Choice for Canadian DIY Investors

The Problem – Choosing the Right US Market Exposure

You’ve decided to add US equities to your portfolio but now comes the tricky part—choosing between the S&P 500 or a total US market ETF. They both sound great, but which is right for you?

 

If you follow business news or even more general news that has a segment on the financial markets, you are probably at least somewhat familiar with the S&P 500 stock market index. Because it is well-known, many DIY investors default to the S&P 500. In Canada, two of the biggest such Canadian-listed ETFs are ZSP, offered by BMO, and VFV, offered by Vanguard.

 

I don’t have any more solid explanation than familiarity, but it seems that relatively few consider whether the additional diversification of a total market ETF like VUN, the Vanguard Total Market Index ETF, might be better. In terms of the level of investment, though, the answer is clear since ZSP is about twice the size of VUN.

 

Could you be leaving money on the table—or taking unnecessary risks—by picking one over the other?

 

The Complication – It’s Not as Simple as It Seems

One way to assess the relative benefit of an ETF that tracks the S&P 500 or a US total market index is to look into the historical returns. Thanks to Norman Rothery’s Periodic Table of Annual Returns for Canadians, I was able to isolate these two categories for the period 2001 to 2024. The data shows nominal pretax returns in Canadian dollars.

 

The Wilshire 5000 index is one of several US total market indices. However, no ETF in Canada currently uses the Wilshire 5000 (although 3,403 stocks are included in the index, not 5,000) as its underlying index. Instead, VUN uses the CRSP US Total Market Index with about 3,624 stocks, while XUU, the next most popular US total market index ETF in Canada uses the S&P Total Market Index, with 2,526 individual stock holdings in its index.

 

 

As you can see, both indices are quite close to each other in terms of their annual performance. Both have performed well but with meaningful differences in volatility and leadership.

 

Volatility

For a measure of volatility, I will use the 10-year and 5-year standard deviations. The ten-year figure for ZSP and VFV alike is 12.8%. However, for VUN the standard deviation increases to 13.2%. XUU does not have a 10-year record, but for five years, its standard deviation is 14.4%. Overall, it appears that the ETFs that track the S&P 500 are less volatile than those ETFs that follow a US Total Market Index.

 

 

To clarify, the standard deviation of investment returns measures how much the returns of an investment are likely to vary around the average (expected) return. A higher standard deviation means returns are more spread out, indicating greater potential volatility or risk.

 

For example, if an ETF has a long-term expected return of 7% and a standard deviation of 13%, that means:

 

  • Within one standard deviation (68% likelihood): The returns are expected to fall within a range of 7% ± 13%.
    • Lower range: 7%−13%=−6%
    • Upper range: 7%+13%=20%

 

So, approximately 68% of the time, the ETF’s annual returns will range from -6% to 20%.

 

This range helps investors understand the typical ups and downs they might expect from the investment.

 

Performance Leadership

As the table above shows, for the first half of the twenty-four-year period that has been completed this century, the Wilshire 5000 US Total Return Index outperformed the S&P 500 Index. However, in the second half, that is, from 2013 to 2024, inclusive, the S&P 500 was consistently a better performer. You may find it interesting, though, to learn that in terms of compounded returns from the beginning of 2001 to the end of 2024, the Wilshire 5000 outperformed the S&P 500 by a margin of 0.2%, that is, 8.5% versus 8.3%.

 

While US total market indices are dominated by the largest companies in the US, they have meaningful exposure to mid- and small-capitalization companies as well, which influences total market performance versus the large-cap-only S&P 500.

 

Behavioural Biases

Another factor that may lead to a choice of an ETF tracking the S&P 500 Index is the well-known tendencies we humans have to behave in certain ways.

 

Recency Bias: Many investors choose the S&P 500 based on its strong recent performance, which has been largely driven by large-cap tech stocks. These same stocks are included in total market indices, but they have slightly less weight so that more room can be given over to the smaller companies. While historically, smaller companies have performed better than larger companies, that situation has changed in recent years, leading to ETFs that track the S&P 500 outperforming the more diversified US total market index trackers. The table immediately below gives you a sense of that difference and if we were to continue to tally up the relative weightings, the difference would increase.

 

 

Familiarity Bias: Investors know S&P 500 giants like Apple, NVIDIA, or Microsoft, but they may overlook growth opportunities in small-to-medium-sized companies.

 

Just to add a little more complexity, despite the recent outperformance of the S&P 500, Modern Portfolio Theory (MPT) favours diversification, as does the Efficient Market Hypothesis (EMH), which argues that due to the difficulty (a practical impossibility) of gaining a performance edge on other investors, the best option is to invest widely and own the market rather than try to beat the market.

 

However, the higher public profile of the S&P 500 and the recent dominance of the largest capitalization companies, which the S&P 500 tracks, appeal to investor psychology, which undermines the arguments from theory.

 

The Insight – Understanding What’s Really at Stake

It’s not just about historical returns—it’s about aligning your investment choice with your goals, risk tolerance, and understanding of diversification.

 

Let’s look at the pros and cons of each option:

 

S&P 500 (e.g., VFV):

  • Pros: Lower fees; fewer stocks; exposure to globally dominant companies; strong historical performance.
  • Cons: Lack of exposure to small- and mid-cap stocks; higher sector concentration (e.g., tech).

 

Total Market (e.g., VUN):

Pros: Broader diversification captures the potential for greater growth from small- and mid-cap stocks; aligns with MPT and EMH.

Cons: Slightly higher fees; tracking error can be marginally higher; recent performance differences are minimal but favour the S&P 500.

 

The Resolution – Making an Informed Choice

With this information now established, what guidance can you take from this analysis?

 

It’s popular to debunk the academics and professionals on any variety of topics these days. The mantra, “Do your own research” is an invitation to make choices that are different from what the so-called experts say. However, I would still argue for broad diversification, which when investing in US stocks means buying some type of total market index ETF.

 

This does not mean that those who prefer an ETF that tracks the S&P 500 are going to somehow lose everything while the total market folks are destined to outperform. The two index categories are about 86% the same, which is what you would expect when comparing market-capitalization-weighted ETFs or their underlying indices.

 

I will say, though, that in my opinion, Canadian investors cannot afford to ignore the US market. There are legitimate reasons to put a greater proportion (between 25% and 35%) of one’s investment dollars into the Canadian stock market than is warranted by Canada’s place in the world (about 3% of the world’s total stock market capitalization), but the US is home to almost two-thirds of the world’s stock market value measured by the companies headquartered there, so any thoughts about investment diversification must capture a portion of the US.

 

Having said all that, please remember that fussing over an investment product based on either the S&P 500 index or a US total market index is less important than setting up a portfolio that reflects your time horizon and risk tolerance and that pays attention to costs.

 

Whether you choose the S&P 500 or a total market ETF, the key is that you’re investing in your future with a thoughtful plan. Either option can serve you well in building long-term wealth.

 

 

This is the 275th blog post for Russ Writes, first published on 2025-01-13

 

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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.