Index Fund Anomaly 

The S&P 500 has 500 stocks within

I suppose everyone knows that, but it is interesting to notice that all stocks do not contribute equally to the return. To think about what the index means you need to know a little about how it is constructed.

Selection and weighting 

The S&P 500 approximately owns the 500 largest companies by market value. The approximation is the selection of the last few and the weighting by market value. As prices change by the minute, the index does not. Certainly no fund adjusts that often.

Other factors matter too. Current filing with the SEC, surprise information that results in a trading halt, could matter.

What if you made your own index. 

Suppose your index has only the top 10 of the 500. You would own the largest of the large cap. Would that be good? Sometimes for sure.

Just now, those ten are outperforming the entire index by about 8%. Roughly 18.5% to 11%.

It gets deeper than that. 

The top 10 contain 20% of the market capitalization of the entire index. If 20% of the base returns 19%, that is 3.8% of the 11% the index as a whole has earned. The bottom 490 then made just 7.2%. The S&P 10 outperformed the S&P 490 by nearly three to one.

Ben Carlson publishes something useful nearly everyday. You should follow him. You can find his thoughts on size here.

Learn more

Before you decide indexes are your savior, learn what an index is. It could be an ETF, a managed fund, or even your own portfolio could be better.

Be a little cautious though, the huge cap selection may not always be the winner. When you read Ben’s article you will find that from 1972 to 2013 there is a strange outcome. If you owned the largest stock in the index each year the index as a whole would have done 12 times better. 50 times your money versus 4 times.

Pay attention to the businesses. Huge cap have done some things right to get there. You might wonder who will be next and who will drop away.

They are all businesses and you need to know at least a little about businesses.

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  don@moneyfyi.com  866-285-7772

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