The S&P 500 is probably the most accurate quantifier of the U.S. economy, measuring the cumulative float-adjusted market capitalization of 500 of the nation’s largest corporations. While other benchmark indices measure merely stock prices, which can be limiting, the S&P 500 has been hailed as the market standard against which many funds are compared.
With the advent of exchange traded funds in the late 1980s, it seemed only natural to create an ETF comprised of proportionate ratios of the stocks featured on the S&P 500. In fact, the very first ETF ever created indeed tracked the S&P 500 in such a fashion. While that ETF was quickly sued out of existence, in 1993, investment management company State Street Global Advisors developed an equivalent ETF, the Standard & Poor’s Depositary Receipt, better known by its arachnoid acronym, SPDR (pronounced "spider").
The first SPDR was the SPDR S&P 500 ETF Trust (SPY). Issued in 1993, today it’s the largest and most heavily traded ETF in the world, with assets under management of $374.9 billion, as of May 3, 2022. In fact, SPDR has spawned a whole family of ETFs known as SPDR funds, each of which focuses on a particular geographic region or market sector.
- The three most popular ETFs that track the S&P 500 are offered by State Street (SPDR), Vanguard (VOO), and iShares (IVV).
- All three ETFs have low expense ratios compared to the industry average.
- Most importantly, it should be noted that the three ETFs differ upon their strategy of reinvestment or payment of dividends.
Since its 1993 debut, the SPDR S&P 500 ETF (henceforth “SPDR”) has bought and sold its components contingent on the changing roster of the underlying S&P 500 Index. That means SPDR has to trade out a dozen or so components a year depending on the latest ranking of companies, then rebalance. Some of those components get bought out by other companies, and some lose their place on the S&P 500 by failing to meet its stringent criteria. When that happens, State Street sells off the outgoing index component (or at least, removes it from its SPDR holdings) and replaces it with the new one. The result is an ETF that tracks the S&P 500 close to perfection.
As the definitive S&P 500 ETF, SPDR has inspired a couple of copycats. Vanguard has its own S&P 500 fund, the Vanguard S&P 500 ETF (VOO), as does iShares' Core S&P 500 ETF (IVV). With net assets of over $841 billion and $295 billion, respectively, they along with SPDR dominate this market of funds that aren’t necessarily low-risk, but that at least move in tandem with the stock market as a whole.
All that being said, one S&P ETF should be as good as the next, shouldn’t it? If only. As almost every person who has ever built a fortune knows, you accumulate wealth by spending less of it. That brings us to expense ratios.
Mind the Expense Ratio
State Street charges an expense ratio of 0.0945%, which is more than triple Vanguard’s 0.03%. iShares' comparable ETF has an expense ratio of 0.03%. That seems to make the answer obvious if the question is “Which S&P 500 ETF should I buy?”
If only it were that simple. Whether it’s by virtue of originality, size, or some other factor, SPDR shares are by far the most heavily traded of any S&P 500 ETF. They trade dozens of times as frequently as do Vanguard or iShares S&P 500 ETF shares, making it easy for a prospective seller to convert their holdings to cash. Then again, a thinly traded S&P 500 ETF still trades close to a million units a day. You might have to wait a few hours to be completely liquid, rather than a few minutes. Unless you think you might need to pay a hostage ransom at some point in the near future, that’s little reason to shift out of iShares and into SPDR.
Furthermore, even a 0.0945% expense ratio is vanishingly low. It’s easy to find mutual funds whose expense ratios are 20 times that number. Granted, the latter category consists of funds that require some degree of active management, as opposed to just buying the stocks contained in the benchmark index.
UIT Versus ETF
Another more important difference between SPDR and the other two S&P 500 ETFs is that the first is technically a unit investment trust. Here’s where being an early mover can be a disadvantage; SPDR is bound by an antiquated legal structure that didn’t foresee the creation of myriad ETFs. State Street thus must keep all the shares it purchases in-house. Vanguard’s and iShares’ S&P 500 ETFs are set up differently and are allowed to lend their shares to other firms and earn concomitant interest.
Five hundred stocks in a portfolio mean several hundred dividend payments, too. Rather than deliver those dividends to investors all year long, which would be more than a little cumbersome, SPDR holds the dividend payments in cash and doles them out upon distribution. iShares reinvests the dividends, which is beneficial in a bull market. Meanwhile, Vanguard invests its daily cash in its own ultra-low-risk investment vehicles.
The Bottom Line
For those who reject the concept of beating the market, or the work entailed therein, investing in an S&P 500 ETF makes sense. Be patient and you’ll track the market note-for-note. Best of all, the investment firms have already performed the task of purchasing the proper amounts of each component of the S&P 500, bundled them into a unit, and made them available in small enough slivers that anyone who wants a piece can buy one. For the modest expense ratio, that’s an excellent bargain.