The Vanguard 500 Index Fund Investor Class ("VFNIX") and the SPDR S&P 500 ETF ("SPY") are similar investment products. Both track the S&P 500, a US. stock index comprising 500 companies with the largest market capitalizations. Both funds have expense ratios that are significantly lower than that of the average fund. Most importantly, both offer excellent long-term track records. In fact, several studies have shown that passively managed index funds and exchange-traded funds (ETFs) that track broad market indices outperform the vast majority of actively managed mutual funds. The difference in returns becomes even more striking when you consider that index funds and ETFs impose lower fees than actively managed funds.
As a long-term buy-and-hold investor, you cannot go wrong investing in the Vanguard fund or the SPDR ETF. Subtle differences exist between the funds, though they fulfil the same investment objectives. Before deciding between these two funds, understand their differences in fees and performance, and learn what other considerations to keep in mind.
The good news is that both funds charge a small fraction of what you would pay annually for an actively managed mutual fund. The average mutual fund has an expense ratio between 1.25% and 1.5%. By contrast, the Vanguard fund had a net expense ratio of 0.17% in 2015, while the net expense ratio of the SPDR ETF was an even lower 0.09%.
The extra percent you save in fees with these two funds, relative to that of the average fund, effectively gets added to your annual return on investment. Remember, as well, that actively managed mutual funds, despite the allure of having a professional pick and choose your investment basket, usually underperform when compared to index funds and ETFs, particularly when factoring in management fees.
Because both funds are constructed to track the S&P 500 Index, the difference in their performances, as with their fee difference, is very small. Since 2011, both funds have slightly underperformed the S&P 500 each year, but only by a few hundredths of a percentage. They have effectively moved in lockstep with the broader index, and thus it's important that, like all broad US. stock indices, the S&P 500 has never gone anywhere but up over the long term. Buy-and-hold investors enjoy returns from the S&P 500 that average between 9 and 10% per year, even after you factor in the nightmarish years with substantial losses, such as 1987 and 2008.
Both funds are excellent investments with low fees and strong track records. It ultimately comes down to whether you prefer an index fund or an ETF. Additional factors to think about include tax implications and sales commissions.
Generally speaking, ETFs are slightly more tax-friendly than mutual funds. They feature fewer taxable events, such as a fund manager rebalancing the fund by selling shares of certain securities, which happens regularly with a mutual fund. If these funds are sold at a gain, you owe capital gains taxes for the year they are sold, even though you had no say in their sale. With ETFs, the manager does not have to sell specific shares to manage inflows and outflows. Therefore, you are less likely to realize capital gains in a given year, and your tax bill is often lower.
On the other hand, mutual funds that do not charge "loads," or commissions, typically cost less to purchase than an ETF. Vanguard is known for selling no-load funds, so you should not pay a sales commission if you invest in the Vanguard 500 index. By comparison, an investor purchases ETFs through a broker, just like for individual stocks. Therefore, you pay a commission upon purchase. This is particularly disadvantageous to investors who employ strategies such as dollar cost averaging, which involves making frequent investments at set intervals.