You know there are so many ways that the one size fits all claim has let me down in life. From everything from hat sizes to lawn chairs, trying to make one size work just isn’t comfortable.
The world of investing has been trying to make a one size fits all claim for a couple years now with index investing. And I’m not saying Index investing is a bad thing, but like we’ve harped on for years now, no matter what you’re investing in you have to know what you’re buying.
Index investing has been ruled by the S&P 500 on the equity side. As we’ve said before the S&P 500 is a market cap weighted index. This means that the percentages of what makes up the index are proportional to the size of the company. This index has been increasingly weighted toward the big 5 tech stocks and that trend has continued this year as the global shakeup caused by COVID has only exacerbated the issue.
The big movers have been the tech names, making their share of the overall market larger than ever. As of right now roughly 22% of the S&P is in Apple, Microsoft, Amazon, Facebook, and Alphabet (Google). This is about an 8% increase in index makeup since February last year.
This means that if you use the S&P as your stock portfolio in a 60/40 you are investing 13% of your portfolio in those 5 companies. Is that a bad thing? Maybe, maybe not, but it’s definitely something you need to be aware of.
With 5 companies comprising over 1/5 of the most popular stock index, the S&P is making less and less sense as a one size fits all solution for diversification. This situation puts more responsibility on the investor to manually diversify to avoid the unwanted risk of having a large portion of their assets invested in a few stocks.
And this isn’t just something we’re over here squawking about; this is a legit situation that any index investor needs to be aware of. These super companies getting bigger and bigger makes it more and more dangerous to treat index investments as something that you can set and forget. Their composition changes based on their rules and if you’re going to use them as an investment, this is certainly something you need to take into account, especially with the growth rate we’re seeing from the word’s biggest names right now.
All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.