So today, Apple’s market cap hit two trillion dollars, only about eighteen months since it hit one trillion dollars. Apple, Amazon, Alphabet (parent company of Google), Microsoft and Facebook are, by themselves, twenty percent of the S&P 500 Index, which as the name implies comprises 500 large publicly traded US companies. A big chunk of my IRA and 401(k) money is invested in an S&P 500 Index fund.
So should I be worried that so much is concentrated in only five companies, all of which are in essentially the same industry? I’m wondering if I should shift to a broader index.
Yes, those stocks will have weighted affect on the S&P 500 and thus your portfolio. But the S&P 500 represents about 75% of the US economy, from a representation factor…which tells you how important Tech stocks are to the US economy overall. It wouldn’t hurt if you want further diversification to move some % allocation to the Russell 3000, or split between Large Cap index, mid cap index and small cap index funds.
Particularly given the extra special impact of COVID & politics on the USA right now I’m starting to think that diversification into other US stocks or funds is still leaving all the eggs in a somewhat rickety basket.
Many pundits recommend a lot more international exposure. And for certain recent decades non-US portfolios have blown the S&P out of the water.
OTOH … In times of world-crisis, the US has historically outperformed in many arenas, especially currency. When a “flight to safety” occurs, in modern times the US has always been the refuge of choice.
How to weigh those two competing notions and how to predict the future is a tough problem.
During the GFC, when it’s source and epicentre was the US, US funds sold off holdings in other regions to bring cash back into the US to staunch the domestic bleeding.
The USD rose on the back of demand to convert non-USD denominations into USD. Other markets underperformed due to the selling pressure.
It wasn’t a flight to safety. It was a flight into the furnace. The US exported a (near) global recession to minimise the implications of flaws in it’s risk assessment of ‘mortgage-backed securities.
So, first of all this is obviously a good problem to have. Most index funds are “cap weighted”, so you own each stock in proportion to its market capitalization, the size of the company. That means you own mostly big companies, and big companies have outperformed small companies over the past 5 years, in large part because of the tech giants. The U.S. has also outperformed all international markets except China, but China has been a wild ride, incredibly volatile.
So - who knows what the future will bring, but if you decide it’s the right thing to diversify, better to be doing it now than 10 years ago.
The accepted wisdom is that a “neutral” weighting for a diversified portfolio is cap-weighting. But I think that’s a questionable assumption. Why would you necessarily want 10 times the exposure to a company just because it’s 10 times the size?
The other issue with cap-weighting comes up with allocation among countries. Is the aggregate size of public traded companies a good indication of the “importance” of a country in the global economy. If you compare market cap to GDP, the most prominent discrepancies are that the U.S. is about 56% of total global market cap but only about 27% of global GDP; whereas China’s market cap is only 5%, with 18% of global GDP.
Thanks for the advice. The biggest chunk of my investments is in a rollover IRA, invested in a Vanguard target-date fund and the biggest chunk of that (45%) is in the Vanguard Total Stock Market Index Fund Investor Shares. So I’m less exposed to a price swing due to changes in those five stocks than I thought. Still, the growth in those stocks has been amazing. Sadly, I don’t own shares in any of them directly.