What it means
Instead of choosing individual shares, an investor in a total stock fund buys a slice of the whole market. If the fund covers, for example, all the listed companies in a country, a single investment gives exposure to thousands of businesses across every industry.
The fund's value moves with the market it covers. Its weighting follows company size, so the biggest companies make up the largest share of the fund, and when large companies do well, the fund does well, which is worth remembering when judging how diversified the fund really is.
Because the fund is usually run by following an index and not by picking winners, its costs are very low. The main running charge is the expense ratio, which is the annual fee as a percentage of the amount invested, and it can be a small fraction of what an actively managed fund would charge.
Cost matters because it compounds. A difference of 0.5% to 1.0% a year in fees may sound small, but over decades it can reduce the final value of a portfolio by a noticeable share, and cost is one of the few things an investor can control with certainty.
A total stock fund does not remove risk. It protects against the failure of any one company, but not against a fall in the whole market, and shares can fall sharply in a recession, so the fund suits money that will not be needed for several years.
The term is generic, and different providers use it for funds with different coverage. Some cover only one country, some include foreign markets, and some leave out the smallest companies, so the fund's factsheet should be checked to see exactly what it holds.
In practice
Real-world examples.
Example
A 30-year-old employee puts monthly contributions into a total stock fund through her workplace pension. She chooses it because it spreads her risk across thousands of companies and charges a low annual fee.
Example
A family business sells its shop for $600,000 and invests $200,000 in a total stock fund for retirement. They plan to leave it for at least ten years, so short-term falls in the market are not a worry.
Example
A university endowment keeps 40% of its portfolio in a total stock fund as the core holding and uses specialist managers around it. The finance committee reviews the fund's fees against the cost of the active managers every year.
Formula
Calculation
Annual fund cost = Amount invested x Expense ratio
Suppose an investor puts $100,000 into a total stock fund with an expense ratio of 0.04%. Annual cost = 100,000 x 0.0004 = $40. A comparable actively managed fund charging 0.80% would cost 100,000 x 0.0080 = $800 a year, so the difference is 800 - 40 = $760 a year, before any compounding effect, which grows as the balance grows.Case study
Seen in the real world.
Clearwater Dental Group is an illustrative, fictional partnership with a $400,000 surplus that it wanted to invest for ten years. One partner suggested picking ten shares, while another proposed a total stock fund.
The finance manager compared the options. Ten shares would concentrate risk, and an actively managed fund charging 0.90% would cost $3,600 in the first year, against $160 for a total stock fund charging 0.04%.
The partners chose the total stock fund and added to it each year from profits. The illustrative result was a diversified holding at very low cost, and the lesson was that for money invested for the long term, the main decisions are how much to put in and how little to pay in fees.
Watch out
Common mistakes.
- Assuming that a total stock fund is diversified across the whole economy, when it may be heavily weighted to a handful of the largest companies.
- Selling in a market fall and so turning a temporary loss into a permanent one, which is a common reason investors fall behind the fund's own return.
- Paying high fees for a fund that offers the same exposure as a cheaper one.
Questions
People also ask.
What is the difference between a total stock fund and a large company index fund?
A total stock fund includes companies of all sizes, while a large company index fund includes only the biggest, so the total fund has more mid-sized and small companies.
Can I lose money in a total stock fund?
Yes, because the fund moves with the market, and it can fall sharply in a downturn, although past recoveries are no guarantee of future ones.
Is a total stock fund a good choice for a business's cash reserves?
Usually not, because share prices are volatile and the cash may be needed at short notice, so reserves are better kept in deposits or short-term bonds.
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