Just One Fund – Is The S&P 500 All You Need?

Why Are We Considering This Now?

When I first started investing properly around a decade ago most of the literature and information sources were heavily biased towards investing in the UK market. Even to this day there’s still far too much emphasis from the media on investing in our home market. FYI, the UK only makes up around 4% of global market cap, so it makes no sense to put all your wealth there.

It took me years to wean myself off this UK focus, and now as our regular viewers will know both Ben and I invest in stocks from all around the world. This wide diversification and global stance is probably what the UK FIRE community advocates most.

However, a lot of Americans only invest in US stocks, particularly the S&P 500, and they do alright. We always put this down to the same sort of home bias that we used to demonstrate ourselves, but one they could get away with as the US stock market and USD dollar is so dominating. 57% of the FTSE ALL-World index is comprised of US stocks.

Also, investing gurus like Warren Buffett have reinforced the idea that the S&P 500 is all you need as he has instructed the trustee in charge of his estate to invest 90 percent of his money into the S&P 500 and 10% into government bonds for his wife after he dies.

For index investors there’s really not that much you need to do, other than invest as much you can and wait for time and compounding to work its magic. We spend most of our efforts on strategies to minimise fees and taxes, so we capture as much of the index returns as possible. In other words, what we’re attempting to do is track the REAL index as closely as we can.

What we’ve learnt is that this is much easier to do with certain indexes like the S&P 500 than it is with others, such as global indexes. So, this raises the question: is it worth paying extra for global diversification… or is the S&P 500 all you need?

What Is The S&P 500?

If you’re considering investing solely in the S&P 500 then we should definitely take a look at exactly what it is first.

The S&P 500 index contains the majority of the biggest and best companies domiciled in the US. The word “domiciled” is key, and we’ll come back to this. The S&P 500 is considered to be one of the best single gauges for the U.S. equity market, and the index captures approximately 82% of the total U.S. equity market value – practically all of it.

It is a market-cap-weighted stock market index, effectively meaning the largest companies make up a larger slice of the index. Everyone will be familiar with the top holdings as it includes huge companies like, Apple, Microsoft, Amazon, Google’s parent company Alphabet, Buffett’s Berkshire Hathaway, and so many more behemoths.

Recently it has become known for its large technology exposure with most of the top holdings being tech giants.

S&P 500 Returns vs The World

We’ve seen some people wrongly assume that the S&P 500’s incredible returns and outperformance over the last few years will continue. Basing investing decisions on historical performance of just a few years is probably madness, but how many years do we need to look over before that madness becomes a long-term trend – potentially signifying a long-lasting advantage?

We decided to compare 51 years of total return data – which was the max we could get – to see how the S&P 500 stacks up against the MSCI world index.

The MSCI world index is an index comprising of 23 developed markets and covers 85% of the market cap of each country.

In annual terms the difference was fairly close, with the world index returning 9.8% vs 10.7% for the S&P 500. But in total terms, that’s a huge difference. $100 invested in the world index would be worth $11,625 vs. $18,197 for the S&P 500 – that’s 56% more!

Bear in mind that as of now, US stocks make up 67% of the MSCI world index, so for the S&P to outperform it by such a large margin, would suggest that US stocks absolutely annihilated the non-US stocks within the world index.

Of course, there’s no guarantee that history will repeat itself, but we think there’s something about the United States that gives its companies a sustained competitive advantage.

Despite this long-term outperformance, there’s something reassuring about the wider diversification achieved by investing in global markets. For the sake of argument let’s assume that we’re all happy to sacrifice that extra potential return. How much is that extra diversification worth paying for?

The Real Cost of Tracking An Index

As we mentioned, the world index returned 9.8% per year and the S&P 500 returned 10.7% per year. Fantastic, but we can’t actually get those returns because there are fees and taxes that will massively drag on what we get to take home.

We think most investors are aware that fees and taxes exist but don’t really understand their magnitude. We hope that what we’re about to show you will shine a light on these unwelcome performance headwinds, and help you organise your investments to maximise after-tax and after-fee returns.

Our favourite investment tool is the ETF, and the most common way to compare ETF costs is with the Ongoing Charges Figure or OCF. OCF’s are extremely useful to get an idea of costs but they too are not fool proof.

Tracking difference is a much better gauge of the true cost but even that has its limitations. Tracking difference is the difference between the returns of the fund and the target index. Unfortunately, all ETF and fund providers mislead their investors about which index they should be benchmarked against.

For example, it would be reasonable to assume that an S&P 500 ETF tracks the S&P 500 total return index, but you’d be wrong. They all track the S&P 500 NET Total Return index, which has a deduction for 30% withholding tax – even though no sensible UK investor would ever pay this much.