How to Select US Equity Index Building Blocks

Difficulty: Intermediate Published: 2025-12-28

Total US stock market index funds deliver 99.5% market coverage across 3,700 stocks using single low-cost fund (0.03-0.04% expense ratio). This approach outperforms actively managed funds by 0.67% annually while eliminating individual stock selection risk and market-segment timing decisions.

The Three Core US Equity Index Options

US equity index funds fall into three categories: total market (complete coverage), S&P 500 (large-cap only), and extended market (mid/small-cap completion). Selection depends on available fund options and whether you need broad or segment-specific exposure.

Decision framework:

• Default choice: Total US stock market index (VTI, VTSAX, FSKAX, SWTSX)
• 401(k) constraint: S&P 500 in employer plan + extended market in IRA for completion
• Intentional tilt: S&P 500 only if deliberately avoiding mid/small-cap exposure

Source: French, 2008. The Cost of Active Investing. Documents that index funds outperform actively managed funds by 0.67% annually after accounting for expense ratios and trading costs across 1980-2006 period.

Total US Stock Market Index (Recommended Default)

Fund Implementations

Vanguard options:

• VTI (ETF): 0.03% expense ratio, no minimum investment
• VTSAX (Mutual Fund): 0.04% expense ratio, $3,000 minimum

Fidelity option:

• FSKAX (Mutual Fund): 0.015% expense ratio, $0 minimum (lowest cost)

Schwab option:

• SWTSX (Mutual Fund): 0.03% expense ratio, $0 minimum

Coverage and Holdings

• Number of holdings: ~3,700 stocks
• Market capitalization range: Mega-cap ($500B+) to micro-cap ($50M)
• Market coverage: 99.5% of US investable equity market
• Weighting method: Market-capitalization weighted (largest companies get largest allocation)

Top 10 holdings (as of 2024, ~30% of fund):

• Apple: 7.2%
• Microsoft: 6.8%
• NVIDIA: 4.1%
• Amazon: 3.8%
• Meta: 2.4%
• Alphabet (Google): 3.9% (Class A + C combined)
• Berkshire Hathaway: 1.7%
• Tesla: 1.9%
• Broadcom: 1.6%
• JPMorgan Chase: 1.3%

Automatic Rebalancing

Market-cap weighting means the fund automatically adjusts to company size changes without manual rebalancing. When Apple stock rises 10%, its weight increases proportionally. When a small-cap company grows into mid-cap range, its weight automatically expands.

Example: Tesla entered S&P 500 in December 2020 at $600B market cap, automatically receiving 1.5% weight in total market index without investors needing to trade.

Use Case and Advantages

Best for: Complete US equity exposure in single fund, avoiding market-segment timing decisions

Advantages over S&P 500:

• Captures mid-cap and small-cap segments (20% of market)
• Historically, small-cap outperforms large-cap by 0.5-1.0% annually over long periods
• Diversification across 3,700 stocks versus 500 stocks

Cost: FSKAX at 0.015% ER costs $15 annually per $100,000 invested

30-year growth: $100,000 invested at 9% return, 0.015% ER → $1,326,768 ending balance

S&P 500 Index (Large-Cap Only)

Fund Implementations

Vanguard options:

• VOO (ETF): 0.03% expense ratio
• VFIAX (Mutual Fund): 0.04% expense ratio, $3,000 minimum

Fidelity option:

• FXAIX (Mutual Fund): 0.015% expense ratio, $0 minimum

Schwab option:

• SWPPX (Mutual Fund): 0.02% expense ratio, $0 minimum

Coverage and Holdings

• Number of holdings: 500 large-cap stocks
• Market coverage: ~80% of US market capitalization
• Missing: Mid-cap and small-cap stocks (3,200 companies, 20% of market)

Selection criteria: S&P index committee chooses companies based on:

• Market cap >$14.5 billion (as of 2024)
• Positive earnings in most recent quarter and trailing 12 months
• Adequate liquidity (trading volume)
• At least 50% of shares publicly traded

Use Case

Primary use: When total market fund unavailable in employer 401(k)

Example scenario: Employer 401(k) offers S&P 500 index fund (FXAIX) but no total market option. Investor uses S&P 500 in 401(k), then adds extended market fund in IRA for completion (see next section).

Secondary use: Intentional large-cap only allocation

• Belief that large-cap offers better risk-adjusted returns
• Simplicity preference (500 stocks easier to understand than 3,700)
• Historical performance: Large-cap outperformed small-cap 2010-2020 (+13.8% vs +11.2% annually)

Performance Comparison: S&P 500 vs Total Market

2010-2020 (large-cap favored period):

• S&P 500: +13.8% annually
• Total Market: +13.9% annually
• Difference: +0.1% favoring total market (small-cap contribution minimal)

2000-2010 (small-cap favored period):

• S&P 500: -1.0% annually (lost decade)
• Total Market: +0.4% annually
• Difference: +1.4% favoring total market (small-cap outperformance)

1926-2020 (full historical period):

• S&P 500: +10.2% annually
• Total Market: +10.3% annually
• Difference: +0.1% favoring total market

The long-term performance difference remains minimal, with total market capturing slight small-cap premium.

Extended Market Index (Mid/Small-Cap Completion)

Fund Implementations

Vanguard options:

• VXF (ETF): 0.06% expense ratio
• VEXAX (Mutual Fund): 0.06% expense ratio, $3,000 minimum

Fidelity option:

• FSMAX (Mutual Fund): 0.035% expense ratio, $0 minimum

Coverage and Holdings

• Number of holdings: ~3,200 mid and small-cap stocks
• Market coverage: ~20% of US market (completion of S&P 500)
• Definition: Everything in total market index NOT in S&P 500

Purpose: Pair with S&P 500 to replicate total market index performance

Completion Strategy Formula

Total Market Equivalent = 80% S&P 500 + 20% Extended Market

This 80/20 ratio mirrors the market-cap weights of large-cap versus mid/small-cap segments.

Example on $100,000 US equity allocation:

• $80,000 in S&P 500 fund (FXAIX in 401k)
• $20,000 in extended market fund (FSMAX in IRA)
• Result: Replicates total market index performance

Rebalancing: Maintain 80/20 ratio annually. If large-cap outperforms and ratio drifts to 85/15, sell $5,000 from S&P 500 and buy extended market to restore 80/20.

Use Case Example: Multi-Account Coordination

Investor accounts:

• 401(k): $240,000 (only S&P 500 index available)
• IRA: $60,000 (full fund selection available)
• Taxable: $100,000 (full fund selection available)
• Total: $400,000

Target: 100% US equity with total market exposure

Implementation:

• 401(k): $240,000 in S&P 500 fund (60% of total)
• IRA: $60,000 in extended market fund (15% of total)
• Taxable: $60,000 in S&P 500, $40,000 in extended market (15% + 10%)

Verification:

• Total S&P 500: $240K + $60K = $300K (75% — target 80%)
• Total extended market: $60K + $40K = $100K (25% — target 20%)

This allocation sits slightly underweight large-cap (75% vs 80% target) and overweight mid/small-cap (25% vs 20% target). Adjust by moving $20K from extended market to S&P 500 in taxable account:

Corrected allocation:

• 401(k): $240,000 S&P 500
• IRA: $60,000 extended market
• Taxable: $80,000 S&P 500, $20,000 extended market
• Result: $320K S&P 500 (80%), $80K extended market (20%) ✓

Expense Ratio Impact Over 30 Years

Expense ratios create permanent drag on returns through daily fee deductions from fund assets. The difference between 0.03% index fund and 0.70% actively managed fund compounds to massive wealth destruction.

Comparison on $100,000 invested for 30 years at 7% gross return:

Index fund at 0.03% expense ratio:

• Net annual return: 6.97%
• Ending balance: $761,226
• Total fees paid: $48,774

Actively managed fund at 0.70% expense ratio:

• Net annual return: 6.30%
• Ending balance: $576,453
• Total fees paid: $233,547

Wealth destruction: $184,773 lost to higher fees (24.3% of final wealth)

The $184,773 difference represents 185% of the original $100,000 investment—fees consumed nearly 2× the initial principal over 30 years.

Fee impact rule of thumb: Each additional 0.10% expense ratio costs approximately $25,000 per $100,000 invested over 30 years at 7% growth.

Application:

• 0.10% ER difference → ~$25,000 cost
• 0.25% ER difference → ~$60,000 cost
• 0.50% ER difference → ~$115,000 cost
• 1.00% ER difference → ~$215,000 cost

Source: Compound interest calculator using 7% annual gross return over 30-year period, comparing fee drag from different expense ratio levels.

Common Implementation Mistakes

Mistake #1: Holding Both S&P 500 and Total Market Funds (Overlap)

Consequence: S&P 500 represents 80% of total market index. Holding both creates 80% overlap, with only 20% incremental diversification from total market's mid/small-cap exposure.

Example of duplication:

• $50,000 in S&P 500 fund (VOO)
• $50,000 in total market fund (VTI)
• Actual exposure: 80% large-cap, 10% mid-cap, 10% small-cap (not the intended 50/50 split)

Fix: Choose ONE approach:

• Option A: 100% total market fund (VTI or FSKAX) for complete coverage
• Option B: 80% S&P 500 + 20% extended market for same outcome

Do not mix total market with S&P 500—they are alternative paths to same destination.

Mistake #2: Adding Separate Mid-Cap and Small-Cap Funds to Total Market

Consequence: Total market fund already holds mid-cap and small-cap at market weights (20% combined). Adding dedicated mid/small-cap funds creates overweight position.

Example of overweighting:

• $60,000 in total market (includes 20% mid/small-cap = $12,000)
• $20,000 in mid-cap fund
• $20,000 in small-cap fund
• Result: $52,000 in mid/small-cap (52% of portfolio) versus 20% market-weight target

This overweight bet requires conviction that mid/small-cap will outperform large-cap—a market-timing decision contradicting index philosophy.

Fix: Total market fund provides market-cap weighted exposure to all segments. Additional mid/small-cap funds unnecessary unless making deliberate factor tilt.

Mistake #3: Chasing Recent Performance Between Large/Small Cap

Consequence: Large-cap outperformed 2010-2020 (+13.8% vs +11.2% for small-cap), prompting investors to shift to S&P 500-only in 2020. Then small-cap outperformed 2021-2022 (+15% vs +10% for large-cap), causing regret.

Cycle of buying high, selling low:

• 2020: Shift to large-cap after decade of outperformance (buying high)
• 2022: Shift back to total market after small-cap outperforms (selling low)
• Cost: 2-3% annual return from mistimed switches

Fix: Total market index maintains market-cap weighted allocation automatically, preventing performance-chasing. Holds more large-cap when large-cap performs well (market cap increases), holds more small-cap when small-cap performs well (market cap increases).

Selection and Implementation Checklist

Step 1: Check available fund options → If total market fund available (VTI, VTSAX, FSKAX, SWTSX): Use it. Done. → If only S&P 500 available (common in 401k): Proceed to step 2

Step 2: Determine if completion needed → Want complete market exposure? Add extended market fund in IRA/taxable account → Comfortable with large-cap only? Use S&P 500 alone → Target ratio: 80% S&P 500, 20% extended market to replicate total market

Step 3: Verify expense ratios <0.10% → Target range: 0.015-0.06% for index funds → Fidelity FSKAX (0.015%) offers lowest cost total market option → Avoid funds >0.20% ER (excessive cost for passive index)

Step 4: Calculate cross-account allocation → Sum all accounts: 401(k) + IRA + taxable + HSA → Apply 80/20 rule across total portfolio, not per-account → Example: $400K total = $320K S&P 500 + $80K extended market

Step 5: Execute purchases → Buy on same day to establish baseline → Use market orders during trading hours (ETFs) or end-of-day pricing (mutual funds) → Confirm trade confirmation shows correct expense ratio

Step 6: Set annual rebalancing reminder → Review each January whether 80/20 ratio drifted to 75/25 or 85/15 → Rebalance if drift >±5% from target → Use new contributions to rebalance before selling

Step 7: Resist urge to add complexity → Do not add mid-cap fund, small-cap fund, growth fund, value fund on top of total market → Total market already holds all segments at appropriate market-cap weights → Additional funds = active bets requiring timing skill

US equity index selection distills to single decision: total market for complete coverage, or S&P 500 + extended market completion when total market unavailable. Both paths deliver 99%+ market exposure at 0.03-0.06% annual cost, outperforming 90% of actively managed funds over 10-year periods while eliminating stock-selection and market-segment timing risk.