S&P 500 vs. Russell 2000 ETF: An Overview

In his book, A Random Walk Down Wall Street, the Princeton professor Burton Malkiel writes:

A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.

This idea is at the core of the debate between active vs. passive money management.

If you find yourself on the conservative end of the active vs. passive spectrum, then investing in exchange-traded funds (ETFs) may be one way to go. You may not beat the market, but you will certainly come close to matching it. In this article, we’ll focus on ETFs that track two of the more popular indexes, the S&P 500 and the Russell 2000.

S&P 500 ETF

The Standard & Poor's 500 (S&P 500) is a market-capitalization, weighted index of some of the largest publicly traded U.S. corporations. Most analysts see the S&P 500 as the best indicator of the U.S. equity market. This index is a commonly used benchmark for many portfolio managers, mutual funds, and exchange-traded funds.

The three most commonly traded ETFs that track the performance of the S&P 500 index include:

  1. State Street’s SPDR S&P 500 ETF Trust (SPY)
  2. BlackRock’s iShares Core S&P 500 ETF (IVV)
  3. Vanguard’s S&P 500 ETF (VOO)

The common theme between all three funds is, of course, the index they track—the S&P 500. Many investors consider this index to be the pulse of the U.S. equity market. It is calculated using the market capitalizations of the 500 largest U.S. companies with stocks listed on the New York Stock Exchange (NYSE) or the Nasdaq Stock Market. Index constituents are selected by a committee, which takes into account criteria such as market capitalization, liquidity, financial viability, length of trading, and other factors.

The oldest and the most widely held of the three ETFs is SPY. As of March 2019, the fund had a net asset value of US$262.83 billion. The fund's expenses come in at 0.09%. While this expense is negligible in a broader asset management context, it is the highest among the three competitors. Even in spite of the higher expense, the fund has superior liquidity, with an average daily trading volume of 30 to 60 times that of IVV and VOO.

When comparing the performance numbers of the three—represented by net asset value (NAV) returns—all three slightly underperformed the S&P500 index over the last 10 years. VOO is the new kid on the block with a fund inception date of Sept. 9, 2010, so, it has fewer years of data for consideration. The SPY returned the lowest of the three funds. The lowered return is to be expected since it has the highest expense ratio among the three ETFs. Also, it must be understood that the funds are comparing to the virtually frictionless S&P 500 Index.

SPY is also structurally different from IVV and VOO in that it is set up as a unit investment trust (UIT) with restrictions on lending the underlying shares to other firms. Additionally, any dividends from SPY constituents for the period are collected and held in cash until distribution, whereas IVV and VOO allow for the reinvestment of dividends.

Russell 2000 ETF

On the opposite side of the spectrum is the Russell 2000 Index that follows the performance of around 2,000 U.S. small-cap firms. Like the S&P, the index is weighted and regularly serves as a benchmark index.

As the name suggests, Russell 2000 ETFs closely track the Russell 2000 Index, which combines 2000 of the small-cap companies in the Russell universe of 3000 stocks. The Russell 3000 tracks nearly 98% of all publicly traded U.S. stocks.

Both the S&P 500 and Russell 2000 indexes are market-capitalization-weighted. Unlike the S&P 500 index, however, the securities in the Russell 2000 index are not selected by a committee, but rather through a formula based on their market cap and current index membership.

The most notable ETFs tracking the Russell 2000 index, in the order of their significance, are:

  1. BlackRock’s iShares Russell 2000 ETF (IWM)
  2. Vanguard’s Russell 2000 ETF (VTWO)
  3. Direxion Daily Small Cap Bill 3x Shares (TNA)

Here again, the higher liquidity of Blackrock's IWM seems to drive its higher expense ratio. Compared to the S&P 500 ETFs, however, all funds tracking the Russell 2000 index command higher fees despite their much lower overall liquidity.

IWM is the heaviest traded Russell 2000 ETF, yet it trades at just one-quarter of the volume of SPDR's SPY. The higher fees of Russell 2000 ETFs are likely due to the increased management effort of periodically balancing a larger number of securities.

Russell 2000 ETFs may look more attractive than S&P 500 ETFs at the start of a bull market. The Russell 2000 constituents on average are bound to outperform their big brothers in the S&P 500 Index if the uptrend continues. The challenge is the volatility of their returns. So, as an investor, you may be in for a rough ride.

Special Considerations

The advantages of ETFs as an attractive investment for those who are content with matching the return on a wider market at a fraction of an active management cost. Investors have many ETFs to choose from based on the size, geographical location, or sector affiliation of companies in the index.

Two of the more popular choices are the S&P 500 ETFs and Russell 2000 ETFs. Key distinctions between them are driven by the size of the companies in the index they track—large-cap for the S&P 500 and small-cap for the Russell 2000—the volatility of the underlying index, the method of constituent selection, and the fees they charge. 

Key Takeaways

  • The S&P 500 and the Russell 2000 are two popular indexes.
  • Many investors consider the S&P 500 to be the pulse of the US equity market.
  • Russell 2000 ETFs closely track the Russell 2000 Index, which combines 2000 of the small-cap companies in the Russell universe of 3000 stocks.