Index Funds

In part 1 of this post we looked at the summary tab of the fact sheet for Schwab’s Total Stock Market Index Fund, SWTSX. We looked at share price, expense ratio, dividends, and returns. In this post we’re going to discuss what is actually in the index fund and how to track its performance.

Buy all the Stocks

Like the name implies, an American total stock market fund holds all of the publically traded companies in America. But each company isn’t weighted the same. If it were you would be buying the same amount of Crocs (the weird shoe thing) as you would be Apple or Facebook. You may want to do that, but in general Indices are weighted so that you are more invested in bigger, more stable companies that are less likely to go bankrupt.

One of the upsides of this weighting is that as companies grow and shrink so do their weight in the index. This mean that a company that is growing very fast will become worth more in the index thus causing your investment to grow faster with it. And companies that lose value lose their weighting in the index so they don’t bring your down with them.

So how can you tell how the index fund is weighted? If you click over to the portfolio tab you’ll get information about the fund’s holding. First you’ll see a map showing you where the fund’s companies are located. In this case they are primarily located in North America which makes sense for a total US stock index. To the right you’ll see the total assets and holdings. This fund holds 3,366 companies for a total of $17 billion. The nice thing about a total stock index is that your investment will never go to zero because it’s virtually impossible for all 3,366 companies to go bankrupt at the same time. (And if they do you’ll have more important things to worry about)

What companies are in my fund?

Below the map is a list of the top 10 holdings. You’ll see familiar names like Apple, Microsoft, Amazon, and Facebook. Alphabet Class A and C are both Google shares. You’ll hear a lot about the FAANG stocks in the news and you can see here that they make up a good portion of the total stock market. So when they go up it’s good news for you! Number 7 is Tesla so if you wanted to get in on the massive Tesla craze, but didn’t want to invest $700 for a single share, you can just by investing in a total stock index.

At the bottom you’ll see that the top 10 holdings consist of 22.68% of the entire fund. This is due to how the fund is weighted. Apple alone makes up 5% of the 3,366 companies. That’s how rich of a company Apple is. Just remember that next time you buy an iPhone. (Google makes up 3.5% so there’s that…)

So when you feel pressured to invest in Tesla or Amazon or anyone of the big names posting ridiculous gains, remember that a total stock index fund or an S&P 500 index fund is investing in all of these big names, but without the risk that comes from investing in a single company. Putting $10,000 into this index fund is equivalent to investing $314 in Amazon. But you also have 3,365 other companies that can help balance your risk.

Fund Performance

Now for the most important part: how did the Index fund perform? If you go over to the performance tab it will show you the returns over specific time intervals (YTD, 1 day, 1 month, and 3 months) as well as annualized returns for 1 year up to 15 years.

You can see that the 15 year returns are lower than those of the 1, 3, 5, and 10 year stats. This is because the 2008 financial crises is now more than 10 years behind us. Since 2009 we’ve been in the longest bull market in history. (It technically ended in 2020 with Covid, but as you can see from the 1 year returns, Covid hasn’t really hurt the stock market like we initially thought it would in March of 2020.)

Benchmarks

Below SWTSX you can see the returns for the S&P500 TR USD index. TR stands for Total Returns. It includes dividends as well as capital gains. This is the benchmark which Schwab is measuring against. The two diverge a little bit because the Total Stock Market Index isn’t the same as the S&P 500 Index, but they share much of the same investments since they are both weighted by the value of the richest companies.

Below that you’ll see the Large Blend category. This is the average returns of all the mutual funds consisting of top companies. Remember from the last post that SWTSX is considered a Large Blend fund so this screen compares the fund to the average returns of funds in its category. You can see from this comparison that the average Large Blend fund lags SWTSX (and the S&P 500) in every time span.

So what this is saying is that you have a better chance of making money by just investing in this total stock index fund than you do by paying some fancy fund manager to invest for you. Here is a list of Morningstar large blend funds. What you’ll notice looking at the list is that their Expense ratio is somewhere around 1%. That means you’re paying 1% in fees to get 1% less returns over a 15 year time span. If you had $100,000 invested in both SWTSX returning 10.82% and the average Large Blend mutual fund returning 9.83% with a 1% expense ratio, After 15 years the SWTSX fund would have $111,132.70 more in it. Expense Ratio fees are the worst! Which brings us to…

Fees

If you go over to the Risk & Tax Analysis tab it will show you the projected returns over your time intervals when accounting for taxes. It will give you the pre-liquidation and post-liquidation estimates which are just the estimated returns based on taxes.

Schwab notes that the “Numbers are adjusted for possible sales charges, and assume reinvestment of dividends and capital gains over each time period.” And “Pre-liquidation (before sale of shares): includes taxes on fund’s distributions of dividends and capital gains. Figures based on highest Federal income tax bracket. State and local taxes are not included.”

This isn’t really interesting to us since the majority of typical middle class Midwestern families use an IRA or 401(k) to invest in the stock market. And if you are using a taxable brokerage account to invest in index funds you’ll likely have long term capital gains. You also won’t be in the highest Federal income tax bracket anyway so these values aren’t super helpful.

But what is helpful is the fees section at the bottom. You’ll see that the gross expense ratio and the net expense ratio are equal. This is normal for index funds. You’ll also see the Morningstar category average. Remember the list of Morningstar large blend funds? We estimated that they averaged about a 1% expense ratio. That looks to be a pretty good back of the napkin guess as the actual average is 0.83%. The average large blend mutual fund costs 27% more in fees and nets you a whole percentage point less in gains! A lose-lose situation. Fees are the worst.

Conclusion

In this 2-part post we discussed how to read an index mutual fund fact sheet. We learned how to navigate the sheet to determine expense ratios, returns, and dividends. We also saw how to determine a fund’s holding and see if it was performing well against its stated goal.

What do you think? Does this help make it easier to understand fund sheets? Let us know in the comments below!

If you’ve been reading this blog and you read posts like What Investments to Actually Buy you’ve probably got an idea of why index funds are the way to go for the average Joe investor. They’re simple, plentiful, and, most importantly, cheap! But how do you know what you’re actually investing in? In this post I’ll show you how to read an index mutual fund fact sheet.

Let’s say you’ve decided to invest in the Schwab Total Stock Market Index Fund. If you google that, it’ll bring you to a page that looks like this.

The first thing you may notice is the bold jumble of letters: SWTSX. This is called the ticker symbol. It usually tries to represent the name of the company or fund it symbolizes. For example the Ticker symbol for Google is GOOGL. SWTSX stands for SchWab Total Stock indeX. It sort of makes sense.

The next line has the NAV or net asset value. The NAV is the price of one share. If you want to buy one share of this fund today it will cost you $77.68. But since this is a mutual fund you don’t need to buy whole shares. If you look down towards the bottom of the picture you’ll see the minimum investment requirements. In the case of this index fund the minimum investment is $1. This isn’t always the case for index funds. For example Vanguard’s total stock index fund (VTSAX) has a minimum initial investment of $3000.

Expense Ratio (Less is Better)

Next to NAV is the daily change. The index went down 0.05% yesterday, boo. With mutual funds, they are bought and sold only once per day at 4 p.m. Eastern Time, after the market closes. This is different than ETFs or exchange traded funds. ETFs can be bought and sold on the market floor many times throughout the day just like an individual stock.

Next you’ll see what’s arguably the most important number: the Net Expense Ratio. This is also called the Management Expense Ratio or MER. The expense ratio for SWTSX is just 0.03%. That means for every $10,000 you have invested Schwab will take $3.00. Remember the average actively managed fund has an expense ratio of 1-2%. That’s a fee of $100-$200 for every $10,000 invested. So 0.03% is not bad at all!

The next section is the year to date (YTD) return. So far as of 7/31/2021 SWTSX has returned 17.23%. This means if you invested $10,000 into SWTSX on January 1^st, by now you have made $1,723 in gains. The overall market average for the last 100 years has been about 10% so 2021 has been a good year so far for investors.

Below these under Fund Strategy, you’ll see the goal of this index fund. “The investment seeks to track the total return of the entire U.S. stock market, as measured by the Dow Jones U.S. Total Stock Market Index.” The goal of SWTSX is to track the Dow Jones U.S. Total Stock Market Index. Seems straight forward enough. This is why it is so cheap. You’re not paying any fund manager to attempt to pick the winning stocks, they’re just following a publically available index.

Performance and Dividends (More is More)

Above fund strategy you’ll see a graph of the fund’s performance over the last 10 years. If you had invested $10,000 into SWTSX in August of 2011 it would have grown to over $40,000 by now. Schwab compares that to two other options the S&P 500 TR and the average Large Blend fund. We’ll discuss this more later.

In the details to the right you’ll see some of the same information as we’ve seen above. It also includes the distribution yield. The distribution yield includes the dividends and capital gains and is seen as a percentage of the NAV In this case it’s an average of the last 12 months of dividends and capital gains divided by the price of the stock. Under that you can see that the most recent distribution was $1.0805/share. I you divide $1.0805 by $77.68 you get 1.39%.

If you click over to the Dividends and Distributions tab under fund performance it’ll show you the distributions over the value of the stock shares. If you hover over the points you’ll see that this fund pays its dividends and capital gains at the end of December. This is pretty common. Most companies pay dividends quarterly, but most index funds usually just save this up and pay them out at the end of the year.

Risk vs. Reward (Equal is More)

If we scroll down the page you’ll get the names of the account managers and how long they’ve been managing the fund. This doesn’t matter for an index fund because the manager’s only job is to see that it follows the index. For an actively managed fund the manager’s job is to pick winning stocks so his history and experience with the fund is important. Why would you trust your money to someone who’s only been doing it for a couple years and never seen a stock market crash?

To the right of that you’ll see the Morningstar rating. This is considered a Large Blend fund. Large meaning mostly large capital, big companies, and Blend meaning a blend of stable companies like Johnson and Johnson and ones that have seen considerable growth like Amazon.

Then there’s the Portfolio weightings. This says that 26.92% of this index fund is in Information Technology like Apple, Microsoft, and Netflix. The next biggest weighting is in health care which makes sense because health care will always be needed. Financials is mostly banks which are usually pretty good at making money (you gotta have money to make money I guess).

Down at the bottom you’ll see the risk vs reward meters. The historic return and the historic risk are both above average. This makes sense since stocks are risky and risk and reward are usually well correlated. If you see a fund that has above average return and below average risk, you should be wary of it, and if you see a fund with high risk and low reward, you’re probably better off investing elsewhere.

Conclusion

We’ll finish this up next post discussing what’s actually in this index fund and how to see if it’s performing well against the stated goal.

What do you think? Does this help make it easier to understand fund sheets? Let us know in the comments below!