For most of the people reading this, the S&P 500 is basically the stock market. At least in the United States, it’s the benchmark against which fund performance is judged.
And then I read this article by Schwab that lays out the discrepancy between what people thought they were getting and were actually getting with their index fund ETFs. I’ll let you read the article on your own (but seriously, read the article). There’s this great table in there with some familiar faces:
The smallest components of the S&P 500 index, by the way, have market caps in the one-billions of dollars. Even if the Schwab 1000 inclusion should logically come before a “Top 500” index inclusion, these all outrank players in the S&P 500.
I knew that I didn’t want the S&P 500; I wanted the Top 500 and assumed that the two were equivalent. But any subjectivity in the process edges toward stock-picking, which is (with the sole exception of Warren and his breakfast meals from McDonald’s) suboptimal. Schwab lays out this difference in the table below:
To be clear, there is inherently more risk in a Top 1000 index versus a Top 500 index. If I had more time and interest, I’d probably look at the difference in performance between the S&P 500 and a Top 500 fund, but I’m lazy and the I trust the table.
Which brings me to my dilemma: how do I switch over, in a tax-efficient manner? Capital gains (the profit on your investments) are taxed at two different rates, depending on how long you’ve held the investment (the cutoff is one year). Is the right strategy to immediately ditch all of my holdings in the S&P and switch everything over to the Schwab 1000? Is it to move over stuff as it gets classified as long-term? Is it to just never sell and delay paying taxes as long as I possibly can? I don’t think the first strategy is right – the difference in return over the course of 365 days is highly unlikely to outweigh the extra taxes I’d pay for impatience. I ended up going with the second strategy, since I know that even a couple tenths of a percent over the long run can result in an appreciable difference after a couple of decades. Here’s how that manifests using the 25 year numbers with an initial investment of $250K:
Perhaps someone more knowledgeable in the dark arts of tax accounting could guide me.
I am not providing or intending to provide tax, legal, or accounting advice. This blog post is for informational purposes only, so please don’t rely on it for tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before engaging in any transaction. I’m just a guy on the internet. Please don’t sue me.