The S&P 500 has been in the news a lot lately because of the roller coaster ride it has had investors on over the past couple of months. Chances are, you are one of those investors and know just what I’m talking about.
The S&P 500 always makes headlines because it is commonly used as a proxy for the U.S. stock market as a whole. It is made up of the country’s 500 largest publicly traded companies, hence the 500 in the name. However, each company does not have equal influence over the movement of the index.
What Is A Capitalization-Weighted Index?
The S&P 500 is a capitalization-weighted index. That means that companies with greater market capitalization, the bigger ones, carry more weight. Therefore, the bigger the company, the more it impacts the overall index performance. When a small company struggles, it barely affects the index. However, when a large company has an outstanding quarter, the entire index shoots up.
Who Is Driving The S&P 500?
Being capitalization-weighted means that the biggest companies drive the entire index. How big is the disparity between the influence of large and small companies? The top 1% represent 45% of the benchmark return.
The largest company in the S&P 500 is Amazon.com, Inc., and it contributes 15% of the index’s returns. The second largest company is Apple, Inc., which contributes 14%. These two companies alone represent more than a quarter of the index’s total returns.
The other companies that round out the top 5 are Microsoft Corporation, Netflix, Inc., and Mastercard, Inc. Those 5 companies alone cause 45% of the movement of the S&P 500. A full two-thirds of the returns are dependent upon the top 15 companies. That means that the other 485 companies can be losing value, but as long as those 15 companies are doing well, the index will show positive returns.
Why Does This Matter?
The fact that the S&P 500 is weighted in this way gives a somewhat distorted picture of the market to investors. While the headlines may say that the market is up, and the S&P 500 is indeed up, many investors with balanced portfolios won’t see the same gains.
Unless your money is invested 100% in the S&P 500, your returns won’t match those of the index. For most investors, a balanced portfolio that accurately reflects their goals and risk tolerance will not match the index exactly. So, if your portfolio isn’t keeping up with the S&P 500, that doesn’t mean that your advisor isn’t doing his job. It probably means that he is doing his job.
When developing an investment portfolio, it is important to look at each client’s individual goals, needs, and time horizon. While you may feel like you are missing out when the S&P 500 is outperforming your portfolio, how would you have felt if you were retiring in the fall and you had been invested only in that index? You would have been scared to death with the way it was dropping and would have lost money when you took it out at the low point to pay for living expenses.
Need Help With Your Portfolio?
The timeline of someone entering retirement warrants a more conservative portfolio. While it won’t see the same gains as the market as a whole, it would also be protected from the same losses. At 1on1financial, we look at the big picture and match your portfolio to your unique needs, not necessarily the overall market. If you have questions about your portfolio or want to make sure that it matches your own specific needs, give us a call at909-981-1720 or try out our free risk analysis tool today.
Philip A. Board MSFS, CFS, is a retirement planning specialist and the founder of 1on1financial, an independent comprehensive investment firm serving individuals and businesses throughout the United States. He is also the owner and CEO of Medi-cal Benefits.