5 Critical Reasons Why You Should Stop Buying SPY ETF and Start Buying VOO

Are you currently investing in the S&P 500 through the SPY ETF? You might be missing out on a superior alternative in the investment world.

The ETF comparison between SPY and VOO reveals crucial differences that could significantly impact your long-term returns.

Many investors automatically choose SPY due to its popularity and liquidity, but is that really the optimal choice for your portfolio?

Understanding SPY vs. VOO: The Fundamentals

Before diving into why you might want to switch from SPY to VOO, let’s clarify what these investment vehicles actually are. 

Both SPY and VOO are exchange-traded funds (ETFs) that track the S&P 500 index, which consists of 500 of the largest publicly traded companies in the United States.

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So what exactly are SPY and VOO anyway?

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They’re both ETFs that track the S&P 500, but with different histories and management companies.

SPY, officially known as the SPDR S&P 500 ETF Trust, was the first ETF launched in the United States back in 1993. It’s managed by State Street Global Advisors and remains one of the most heavily traded securities in the world.

VOO, the Vanguard S&P 500 ETF, was launched much later in 2010. It’s managed by Vanguard, a company renowned for its focus on low-cost investment products.

Despite being newer, VOO has gained significant popularity among cost-conscious investors.

7 Compelling Reasons to Buy VOO ETF for Long-Term Growth

The Expense Ratio Advantage: Why VOO Wins on Cost

The single most compelling reason to choose VOO over SPY is the difference in expense ratios. An expense ratio represents the annual fee that all funds charge their shareholders. It’s expressed as a percentage of assets under management and is deducted from the fund’s returns.

Let me break it down for you – VOO’s lower expense ratio means more money stays in your pocket over time.

It’s like getting a permanent discount on your investments!

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VOO boasts an expense ratio of just 0.03%, while SPY charges 0.0945% – more than three times as much! This difference might seem negligible at first glance, but let’s examine the real-world impact through a numerical example:

Expense Ratio Impact Calculation

Imagine investing $100,000 in each fund and holding for 30 years with an average annual return of 8% (before expenses):

Difference in final value: $12,742

As demonstrated above, the expense ratio difference leads to nearly $13,000 more in your pocket with VOO over a 30-year period, assuming the same initial investment and returns. This cost advantage compounds over time, making VOO increasingly attractive for long-term investors.

The expense ratio disparity exists primarily because of the different structures and management approaches of the two funds.

Vanguard, VOO’s provider, is known for its relentless focus on minimizing costs and is structured as investor-owned, which aligns its interests with those of its shareholders. 💰

Tax Efficiency Considerations

Beyond expense ratios, tax efficiency is another area where VOO potentially offers advantages over SPY. Tax efficiency refers to how a fund’s structure and management affect the tax liabilities passed on to investors.

Does it really matter which fund I choose for tax purposes?

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VOO benefits from Vanguard’s patented ETF structure, which allows it to minimize capital gains distributions through a unique share class arrangement.

SPY, on the other hand, is structured as a unit investment trust (UIT) rather than a traditional open-end fund. This structure comes with certain restrictions, including limitations on using derivatives and securities lending, which can impact its tax efficiency.

Let’s look at the historical capital gains distributions for both funds:

These distributions matter because they create taxable events for investors holding these funds in taxable accounts. Lower capital gains distributions translate to more tax-efficient growth, allowing you to control when you realize gains and pay taxes.

For investors with substantial holdings in taxable accounts, this difference can lead to significant tax savings over time. 📊

Dividend Reinvestment and Cash Drag

Another subtle but important difference between SPY and VOO relates to how dividends are handled, which can create small performance variations known as “cash drag.”

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Here’s something most investors don’t think about – how quickly dividends get put back to work can impact your returns over time.

Due to its UIT structure, SPY must hold dividends in cash until they are distributed to shareholders at the end of each quarter. This cash position doesn’t earn market returns during the holding period, creating a small performance drag.

VOO, with its more flexible open-end fund structure, can immediately reinvest dividends received from underlying securities. This immediate reinvestment keeps more assets working in the market and can lead to slightly better performance during rising markets.

Over long periods, this difference in dividend handling contributes to a phenomenon called tracking difference – the gap between the fund’s returns and the actual index returns.

Historical data consistently shows VOO maintaining a smaller tracking difference than SPY, meaning it more closely matches the actual performance of the S&P 500 index. 🌱

That’s why I like Income ETFs That Made $2,000 in Passive Income This Year

Tracking Difference Explained

Tracking difference is the annual difference between an ETF’s actual return and its benchmark index return. It’s the real-world implementation cost of the investment strategy.

This means VOO typically captures more of the index’s actual return than SPY does.

Liquidity and Trading Considerations

The one area where SPY maintains a clear advantage over VOO is in trading liquidity. SPY is one of the most heavily traded securities in the world, with average daily trading volumes often exceeding 70 million shares and extremely tight bid-ask spreads.

VOO, while still highly liquid by normal standards, trades at volumes typically around 3-5 million shares daily. This makes SPY potentially more suitable for active traders, day traders, and institutional investors who need to move large positions quickly with minimal market impact.

For most individual investors with a buy-and-hold strategy, however, this liquidity advantage is largely irrelevant. If you’re purchasing shares to hold for years or decades, the microseconds of execution time or fraction of a penny in bid-ask spread won’t meaningfully impact your investment outcomes compared to the ongoing expense ratio savings. 🕰️

It’s worth noting that both ETFs have plenty of liquidity for the average retail investor. Unless you’re regularly trading thousands of shares or employing sophisticated trading strategies that require immediate execution, VOO’s liquidity is more than sufficient for most investment needs.

Conclusion

When weighing the decision between SPY and VOO for your S&P 500 index exposure, the evidence clearly points to VOO as the superior long-term investment vehicle for most investors.

The substantial expense ratio advantage, enhanced tax efficiency, and improved dividend handling collectively give VOO a meaningful edge that compounds over time.

SPY’s liquidity advantage, while significant, primarily benefits institutional investors and active traders rather than typical buy-and-hold investors focused on long-term wealth building.

For the vast majority of individual investors, especially those with time horizons measured in years or decades, VOO represents the more efficient choice.

If you’re currently holding SPY in a taxable account, consider the tax implications of switching before making any moves. For new investments or within tax-advantaged accounts like IRAs and 401(k)s, VOO’s advantages make it the clear winner in this ETF comparison. 🏆

For more: 7 Growth ETFs I Regret Not Buying Earlier

ETF Shopper

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YouTuber and blogger of the ETF Shopper blog, sharing proven strategies for dividend investing.

Author of Receiving 129 Dividend Payments a Year, a comprehensive guide to building passive income streams.
These days, I earn around $20,000 a year in dividends and share what I’ve learned to help others grow their income through smart, income-focused investing.