What Are They?
- Market-cap weighted index fund ETFs hold each stock in the index in proportion to its market value, and are arguably the core building blocks of a diversified portfolio.
- Weighting by market cap (the most traditional form of indexing) results in low turnover, because as stocks rise in value their weighting in the index rises, so they don't need to be sold. Low turnover reduces trading costs and raises tax efficiency.
- S&P, Dow Jones, Russell and Wilshire are the major index providers. Their indexes divide the U.S. stock market by market cap, and are the basis for ETFs issued by iShares, SSgA, and others.
Why & How To Use Them
- Long term investors looking to build an ETF portfolio need to decide how many ETFs to use to cover US stocks. Fewer ETFs are simpler and more convenient; more ETFs are more expensive to buy and more effort to manage, but provide greater opportunity for rebalancing (see Further Reading below). The choices, from fewer to more numerous, are: (a) 1 Total Market ETF; (b) 2 ETFs covering growth and value; (c) 3 ETFs covering large cap/mid cap/small caps; (d) 6 ETFs covering large cap value, large cap growth, mid cap value, mid cap growth, small cap value and small cap growth; and (e) 7 or more ETFs dividing US stocks by sector.
- If you're assembling a long term, diversified portfolio, don't mix underlying indexes (such as S&P and Russell) because that will lead to overlaps between the funds. Stick with all S&P, all Russell, all Wilshire or all Dow Jones. For that reason, we've grouped the ETFs in the list by underlying index. If ETFs from two issuers use the same underlyiung index, you can mix them.
- Market-cap weighted index fund ETFs have many advantages, including low cost and tax efficiency. However, if you don't believe in traditional indexing, an alternative for your core portfolio may be dividend or earnings weighted ETFs or "quant" ETFs. See Further Reading below.
What to Look Out For
- The Morningstar series ETFs may be less liquid than other ETFs. Morningstar was relatively late to the ETF market and by the time they arrived the Morningstar series ETFs seemed redundant to many people, potentially resulting in lower liquidity and wider buy-sell spreads.
- StateStreet's S&P 500 ETF was among the first ETFs to launch. However, after launching the Mid Cap 400 ETF (NYSEARCA:MDY) which was later sold to another sponsor, StateStreet failed to complete its S&P series with a small cap ETF. So long term investors wanting to cover large, mid and small caps with three ETFs should use the StateStreet SPDR Wilshire series or the series from Barclays or Vanguard.
- The iShares Russell series is the only one to include a micro cap ETF. However, that ETF can be added to any of the other series without risking overlap.
- Vanguard's ETFs have a different structure from other ETFs, and may be less tax efficient. See Further Reading below.
- You can track the market's performance divided by market cap using Seeking Alpha's Market Cap Data Dashboard.
- For a discussion of assembling a core portfolio using ETFs, see Seeking Alpha's ETF Investment Guide.
- Simple ETF portfolios using a total market ETF are easier to manage, but provide fewer opportunities for rebalancing. Here's a list of Total Market ETFs, and a discussion of rebalancing. For an alternative view on rebalancing, see Vanguard's Jack Bogle on Rebalancing: Don't!.
- If you want to get more granular still, consider also Sector ETFs for the core of your porfolio. The downside is that they cost more and involve too much work; see Should You Use Sector ETFs?.
- Some people believe that market-cap weighted indexing underperforms other strategies. More exotic alternatives to consider for a core portfolio include Broad US Dividend ETFs and Leveraged Market Cap ETFs.
- Vanguard ETFs have a different structure from those of other providers. For more discussion of this, see Herb Morgan's The Problem With Vanguard VIPERs ETFs.
This page is part of The Seeking Alpha ETF Selector which sorts ETFs by type, highlights how to use them and what to look out for, and provides links to articles that discuss key issues for investors.