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SPY Vs. VOO ETF: Which Is The Better Buy?


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The SPDR S&P 500 Trust ETF (SPY) and the Vanguard S&P 500 ETF (VOO) are two of the largest S&P 500 index funds available in the market. As both funds track the same index, both have effectively identical strategies, holdings, and performance. On the other hand, VOO is slightly cheaper, with an expense ratio of 0.03%, versus 0.09% for SPY. VOO’s parent company is also more shareholder-friendly, as Vanguard operates as a mutual company, and returns any and all profits to shareholders in the form of lower expenses.

In my opinion, VOO’s lower expense ratio and superior corporate structure make it the stronger fund. Still, these are extremely similar funds, with more similarities than differences.

SPY and VOO – Similarities

Strategy and Holdings

SPY and VOO are both S&P 500 index funds. Said index includes the 500 largest public U.S. equities, subject to a basic set of liquidity, size, etc., eligibility criteria. It is a market-capitalization weighted index.

SPY and VOO both provide investors with well-diversified holdings, product of its index. The number of holdings itself, 500, is quite large, and these are reasonably diversified across all relevant industry segments. Both funds are overweight tech, due to the large market-capitalizations of the larger tech companies, including Apple (AAPL), Microsoft (MSFT), and Google (GOOG). Industry weights are effectively identical between the funds.

(Source: ETF.com)

Neither fund is excessively concentrated, with the top ten holdings of each fund comprising about 28% of their total value. Holding weights are also effectively identical between the funds.

(Source: ETF.com)

The small differences in weights are almost exclusively due to the fact that Vanguard does monthly publishing of its holdings, so the fund’s weights tend to be a bit outdated.

SPY and VOO’s diversified holdings reduce portfolio risk and volatility, and are a significant benefit for the funds and their shareholders. Both funds could function as a core, even only, portfolio holding. Further diversification into small-cap equities and international stocks would be best, but choosing to focus on the S&P 500 index is a reasonable choice too.

As the S&P 500 only includes the 500 largest U.S. companies, both are large-cap funds, with a weighted average market-cap of $534 billion. As a comparison, the Vanguard Total Stock Market ETF (VTI), a broader U.S. equity index fund, has a weighted average market-cap of $440 billion. SPY and VOO focus on large-cap equities, but that is partly, perhaps mostly, a reflection of U.S. equity markets themselves. The U.S. is home to some of the largest corporations in the planet, so investing in the U.S. means investing in these large companies. Focusing on large-cap equities reduces risks somewhat, as larger companies tend to have stronger business models, sturdier balance sheets, and more diversified revenue streams.

As the S&P 500 only includes 500 U.S. companies, both funds lack exposure to thousands of mid-cap and small-cap equities. VTI, for instance, invest in 3935 stocks, more than 3400 more stocks than either of these funds. Although both SPY and VOO are sufficiently diversified, broader equity market indexes are more diversified, and provide investors with exposure to an even greater, broader set of equities. I think pairing SPY and VOO with some smaller investments in small-cap equities or equity funds would be ideal, for the increased diversification. Some investors, however, might prefer to focus on comparatively safer large-cap equity / equity funds, and that is quite reasonable too.

SPY and VOO’s strategy and holdings are generally fine, but there is one significant negative issue. Both funds invest in companies after they become large and successful, and so fail to profit from their rise to the top.

This is easier to show with an example.

Tesla (TSLA) has been one of the most successful companies and investments of the recent past. Tesla revolutionized the automotive industry by designing, manufacturing, and selling the first electric vehicles with broad market appeal, albeit targeted towards more upscale costumers. Tesla has seen skyrocketing revenues and earnings since its IPO in 2010. Shareholder returns have been even stronger, with the stock up about 14,800% since its IPO. These are outstanding returns, much higher than those of the S&P 500 index, and quite rare for public equity markets.

Chart
Data by YCharts

SPY and VOO both invest in Tesla, but that does not mean these funds have benefitted from the company’s skyrocketing share price. The S&P 500 only added Tesla on December 21st of 2020, by which time the company’s share price had already risen. Tesla is up 9.6% since it was included in the index, and added to SPY and VOO, which are reasonably strong returns on an absolute basis, but quite weak on a relative basis. Tesla has been one of the most successful companies and investments of the recent past, but both SPY and VOO waited too long to invest.

Chart
Data by YCharts

As mentioned previously, the S&P 500 index is generally reasonable enough, but the above is a significant negative. I tend to prefer broader equity market indexes like VTI, but the S&P 500 index is large enough, and diversified enough that these issues are not deal-breakers.

Shareholder Returns

SPY and VOO both offer investors consistently strong total shareholder returns. Double-digit annual returns are the norm,. These have occurred for the past ten years or so, and for most other relevant time periods too. VOO’s returns are very slightly higher than those of SPY, due to the fund’s lower expense ratio, but the difference is quite small, and not terribly material.

(Source: ETF.com)

S&P 500 index returns were quite strong in the past, but somewhat lower than above. As per NYU’s Damodaran, the S&P 500 has had annual returns of 11.6%, on average, since inception. These are very strong returns, and extremely beneficial for investors.

S&P 500 returns are consistently quite strong, due to the strength, dynamism, and rapid growth of the U.S. economy, corporate sector, and public equity markets. Extremely few countries or markets are as safe as the U.S., fewer still are as dynamic and fast-growing, and none are both.

SPY and VOO total returns are likely to remain strong as long as underlying economic and industry conditions do likewise, and I think this is quite likely. Economic growth remains strong, unemployment is going down, and inflation is normalizing. Corporate earnings growth are quite strong too:

(Source: JPMorgan Guide to the Markets)

There might be a few negative issues here and there, and coronavirus remains a concern, but the economy seems in very strong shape, and I’m optimistic. As Buffett says, never bet against America.

SPY and VOO both offer investors strong potential shareholder returns, an important benefit.

Valuation Analysis

Equity valuations are a thorny subject right now.

The S&P 500 is clearly overvalued on a historical basis. Valuations were only higher in the late 90s and, well, these led to the dot-com bubble and crash, and the attendant equity market losses. Not the best precedent.

(Source: JPMorgan Guide to the Markets)

Current equity market valuations have, in general, coincided with extremely low future returns in prior years. If history is any indication, SPY and VOO returns will be quite low for the next few years.

(Source: JPMorgan Guide to the Markets)

On the other hand, equities are looking moderately undervalued on a relative yield / interest rate basis. In other words, equities are moderately expensive, but bonds are extremely expensive. Under these conditions, equity valuations look more reasonable.

(Source: JPMorgan Guide to the Markets)

To summarize.

The S&P 500 is overvalued relative to its historical average.

The S&P 500 is undervalued relative to prevailing interest rates.

On net, I think the S&P 500 is looking slightly overvalued myself, but the data is not terribly conclusive, and conditions can always change. I do think it is important to note that the S&P 500 is slowly growing into its valuation. Price returns have lagged underlying earnings growth all year, leading to lower valuations and multiples. The S&P 500 trades with expectations of strong, sustained long-term earnings growth, and the market does seem to be delivering.

(Source: JPMorgan Guide to the Markets)

Dividend Analysis

SPY and VOO offer investors fantastic total returns, but relatively low yields and dividend growth. SPY yields 1.26%, while VOO yields 1.30%, slightly more. VOO’s slightly higher dividend yield is at least partly the result of the fund’s lower expense ratio, but ETF dividends are somewhat noisy, and so I wouldn’t place too much importance on VOO’s slightly higher dividend yield.

Both funds also offer reasonably good dividend growth, but nothing too great. Growth tends to average mid-single digits per year, and seems to be slowing down. Slower growth is likely the result of companies shifting towards share buybacks as an alternative to dividends, due to their more favorable tax treatment.

Dividend growth metrics for both funds are as follows.

(Source: Seeking Alpha)

Technically VOO’s dividend growth metrics are stronger than those of SPY, but, as both funds track the same index, the differences are almost certainly just noise. The vast majority of ETFs, including VOO and SPY, distribute all the income generated by their underlying holdings to shareholders in the form of dividends. The timing of these dividends might vary, which might affect dividend yield and dividend growth metrics, which almost certainly explains VOO’s (supposedly) higher dividend growth metrics.

As an example, SPY had a particularly large dividend payment in 4Q2020:

(Source: Seeking Alpha)

VOO did not, but did have a particularly small dividend payment in 1Q2020:

(Source: Seeking Alpha)

Notwithstanding the above, both funds have similar long-term dividend yields and payments, but the exact figures vary quarter to quarter. These variations are mostly random, the result of slight differences in how funds manage their dividend reimbursements, and not particularly material. On the other hand, these variations can sometimes lead to (short-term) differences in the yield and dividend growth metrics of these two funds.

I don’t have exact figures, but I do remember that VOO’s dividend yield and growth metrics were quite bad during 2020, simply because the fund had an (unusually) low dividend in 1Q2020.

In any case, SPY and VOO both offer investors comparable dividend yields and dividend growth. Neither of these are particularly strong, and so neither fund is an appropriate choice for dividend or income investors: these are capital gains and total return vehicles.

SPY and VOO – Differences

SPY and VOO are extremely similar funds, but there are a couple of small differences that are important for investors to consider.

Expenses

VOO sports a 0.03% expense ratio, compared to 0.09% for SPY. VOO’s lower expense ratio serves to directly increase, or reduce by less, its shareholder returns, and is a benefit for the fund and its shareholders. It’s a small benefit, an increase in 0.06% in annual returns is not particularly impactful, but a benefit nonetheless. I see no reason to overpay for index funds, and so VOO is the obvious choice.

Investment Manager

SPY is administered by State Street, while VOO is administered by Vanguard.

Although I don’t have anything against State Street per se, I think that Vanguard is the superior investment manager. Vanguard is also structured as a mutual company: it is owned by its customers, not by outside shareholders. No shareholders means no profits, which lowers costs for investors. It also ensures no conflict of interest between Vanguard’s shareholders and investors in its funds. The structure makes for a sleepy, low-cost company: perfect for index funds. The structure also ensures that any and all improvements or enhancements to VOO end up directly benefiting investors, and not Vanguard per se. We can’t say the same for SPY and State Street.

As such, VOO seems like the stronger choice.

Liquidity

SPY is the largest, most liquid investment fund in the planet, with over $395 billion in assets, and with an average daily volume of $36 billion.

VOO is the third-largest S&P 500 index fund, with over $212 billion in assets, and with an average daily volume of $1.4 billion.

Both funds are large enough that they are at 0% risk of shutting down, and liquid enough that spreads are effectively zero.

(Source: ETF.com)

SPY’s liquidity is more relevant and beneficial for more aggressive traders, especially option traders. SPY options tend to trade with much lower spreads than comparable VOO options. As an example, let’s have a quick look at some September 2021 call options for both funds. Strike prices are those closest to being in the money, do consider that VOO trades with a lower share price than SPY.

(Source: MarketWatch.com)

As can be seen above, SPY options spreads are much lower than VOO spreads. Due to the above, SPY is the stronger fund for investors looking for S&P 500 options, or for whom these options are part of their overall investment strategy. As an example, investors looking to sell covered calls should consider selling SPY calls, to benefit from lower option spreads.

Which ETF Is The Better Buy: VOO or SPY?

VOO’s lower expense ratio and stronger corporate structure make it the better buy for the vast majority of investors. At the same time, VOO and SPY are extremely similar funds, so expect functionally identical performance from both.



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