Should the S&P 500 be Used as Your Benchmark?
Many investors consider the S&P 500 index the best benchmark for their portfolios because of its breadth and perceived diversification. However, many might be surprised to know that the index is very concentrated in its holdings based on several measures.
What’s Inside the S&P 500?
As of December 2021, the S&P 500 consisted of 505 companies. Those companies are each given weight in the index based on their market capitalization (the total number of outstanding shares of stock times the stock’s current share price). For example, because of Apple’s size, it currently comprises nearly 7% of the index, while the Gap only accounts for about .009% of the value of the index. With the top ten holdings accounting for 29% of the index’s value, it’s easy to see that the largest companies have an oversized influence on the performance of the S&P 500.
The companies within the S&P are placed into 11 sectors. Sectors are a collection of businesses grouped by a shared type of activity, service, or product. These 11 sectors are Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Information Technology, Materials, Real Estate, Communication Services, and Utilities.
You might expect each sector to have an equal 9% contribution to the index; however, because of the weighting of each company in the index, sectors can also have an oversized impact on performance. For example, with a 29% share of the index and a dominating performance, the information technology sector has significantly driven the overall returns of the S&P 500 during the past fourteen years (it outperformed the next closest sector by 3.4% annually during that timeframe). Big tech’s influence over the index is even more pronounced by digging a little deeper into the S&P’s top ten holdings.
Even More Technology Lies Beneath
The S&P 500 currently classifies several of its top ten holdings (see table below) as consumer discretionary or communication services stocks even though they are widely considered technology-related. In fact, the S&P had listed some of these companies as information technology until it reclassified them a few years ago (as referred to in the 2018 reclassification changes below). Adding the weights of Amazon, Tesla, both share classes of Alphabet, and Meta Platforms (formerly Facebook) to the current level of information technology raises the overall “technology” exposure of the index to almost 41%!
This cursory review hints at an even greater overweighting to technology-related stocks when factoring in the other 495 companies. It is no surprise then that a recent study by NASDAQ suggests a very high risk correlation (93%) between the NASDAQ 100 (an index that is heavily allocated to large technology companies) and the S&P 500 between December 2007 and March 2021.
Top Ten Stocks in the S&P 500
|1||AAPL||Apple Inc.||6.78%||Information Technology|
|2||MSFT||Microsoft Corporation||5.95%||Information Technology|
|3||AMZN||Amazon.com Inc.||3.58%||Consumer Discretionary|
|4||TSLA||Tesla Inc||2.11%||Consumer Discretionary|
|5||GOOGL||Alphabet Inc. Class A||2.08%||Communications Services|
|6||FB||Meta Platforms Inc. Class A||1.98%||Communications Services|
|7||GOOG||Alphabet Inc. Class C||1.93%||Communications Services|
|8||NVDA||NVIDIA Corporation||1.72%||Information Technology|
|9||BRK.B||Berkshire Hathaway Inc. Class B||1.48%||Financials|
|10||JPM||JPMorgan Chase & Co.||1.25%||Financials|
Source: Slickcharts.com as of 1/7/22
A Passive Index?
The S&P 500 annually changes its lineup to better reflect the largest 500 public companies in the U.S. Sometimes the changes are few and mundane, but in other years they can be significant. For example, in September 2018, the index underwent a major classification change by moving a considerable number of its companies from the information technology and consumer discretionary sectors into a newly formed communication services sector (formerly referred to as Telecommunication Services). The most impactful of these changes included the reclassification of Google and Facebook (now known as Alphabet and Meta Platforms, respectively)- two of the largest stocks in the index.
More recently, the S&P 500 is considering changes that may greatly reduce its perceived technology exposure further. The previous (and currently proposed) changes were done under the cover of better representing what these companies do; however, most would continue to view the bulk of the reclassified companies as technology companies. With the index’s desire to regularly reclassify technology companies, the conspiracy theorist might be inclined to ask if these changes are being made just to reduce the appearance of an overweight to tech stocks.
Given the annual changes to the underlying companies and the regular sector reclassifications, it may be appropriate to reconsider using the term “passive” when describing the index.
An Ideal Benchmark?
With much of its performance and weighting coming from technology, the S&P 500 could be considered more of a well-rounded tech fund than an appropriate performance benchmark for the typical investor’s portfolio. Rather than using a poorly diversified index as a gauge of your investment performance, consider looking at where you are on your path towards achieving your long-term financial goals as a barometer of your success. Plus, despite outperforming a poorly chosen benchmark, you could still fail to reach your financial goals. After all, reaching those goals is probably the reason why you’re investing in the stock market in the first place.
Investment advisory services are offered by Partnership Wealth Management, a Securities and Exchange Commission Registered Investment Advisor. The commentary presented herein contains the opinions of the firm, and this information should not be relied upon for tax purposes and is based upon sources believed to be reliable. No guarantee is made to the completeness or accuracy of this information.
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Partnership Wealth Management shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses, or opinions contained herein or their use, which do not constitute investment advice, are provided as of the date written, are provided solely for informational purposes, and therefore are not an offer to buy or sell a security. Investments in securities are subject to investment risk, including possible loss of principal. Prices of securities may fluctuate from time to time and may even become valueless. This information has not been tailored to suit any individual
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