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S&P 500 Indexing Is Not A Broad Market Play; Some Alternatives To Consider
any investors misunderstand what they are buying when they invest in the S & P 500 Index. They believe that they are diversified, because they own the "total market". They believe that they have equal positions in 500 of the largest capitalized companies. These investors are mistaken.
Owing to the fact that the S & P 500 Index is "capitalization weighted", investors actually are buying a substantially concentrated portfolio. The concentration is in only a small number of the largest capitalized companies.
That fact has significant consequences for investors. In 1998, the S & P 500 Index increased 26.6%. What stocks contributed to that return? In analyses prepared by Veredus Asset Management, Inc., 46% of the S & P 500 return was due to the 30 largest stocks. The percentage varies. In the first quarter of 1999, the top 30 stocks contributed a hefty 70%; in the second quarter, the percentage was 21%. Overall, for the first half of this year, the top 30 stocks contributed 42%.
The impact of this selective contribution becomes apparent when one re-calculates what the S & P 500 Index would have returned without the contributions of the largest stocks in the Index. The returns are set forth below:
| TOTAL RETURN |
26.6% |
| TOTAL EXCLUDING TOP 10 CONTRIBUTORS |
17.1% |
| TOTAL EXCLUDING TOP 20 CONTRIBUTORS |
13.0% |
| TOTAL EXCLUDING TOP 30 CONTRIBUTORS |
10.3% |
| TOTAL EXCLUDING TOP 40 CONTRIBUTORS |
5.4% |
| TOTAL EXCLUDING TOP 50 CONTRIBUTORS |
3.3% |
Likewise, on a stock-by-stock basis, one can see just how much impact only a handful of the stocks had on the returns of the S & P 500 Index in 1998:
| COMPANY |
% OF AGGREGATE S & P 500 VALUE INCREASE |
CUMULATIVE % OF AGGREGATE S & P 500 VALUE
INCREASE |
| MICROSOFT CORP. |
8.9% |
8.9% |
| WAL-MART STORES |
4.5% |
13.4% |
| GENERAL ELECTRIC |
4.5% |
17.9% |
| LUCENT TECHNOLOGY |
4.4% |
22.3% |
| CISCO SYSTEMS |
4.2% |
26.5% |
| INTEL CORP. |
3.9% |
30.4% |
| MCI WORLDCOM |
3.7% |
34.1% |
| IBM |
3.5% |
37.6% |
| DELL COMPUTER |
3.2% |
40.8% |
| PFIZER INC. |
3.1% |
43.9% |
| MERCK & CO. |
2.4% |
46.3% |
| HOME DEPOT |
2.2% |
48.6% |
| BELL SOUTH |
2.0% |
50.6% |
As concentrated as the S & P 500 Index is, the Nasdaq Composite Index is remarkably concentrated. In 1998, a total of only 4 stocks comprised 57.4% of the return of that Index, as shown below.
| COMPANY |
% OF AGGREGATE NASDAQ MARKET VALUE INCREASE |
CUMULATIVE % OF AGGREGATE NASDAQ MARKET VALUE INCREASE |
| MICROSOFT CORP. |
24.7% |
24.7% |
| CISCO SYSTEMS |
11.7% |
36.4% |
| INTEL CORP. |
10.8% |
47.2% |
| MCI WORLDCOM |
10.2% |
57.4% |
One can see that the S & P 500 and especially the Nasdaq Composite Index are not total market plays. What are some alternatives?
The first alternative is the Wilshire 5000 Index. Actually, the index contains 7,100 stocks, including every company that is traded on a U.S. exchange. However, like the S & P 500, this index also is capitalization weighted. The result of this is weighting is that almost 80% of the Wilshire 5000 is comprised of S & P 500 stocks.
A broader market play is the Wilshire 4500 Index. Quite simply, that index is comprised of all U.S. stocks that are not included in the S & P 500. So, unlike other indexes, this index contains primarily small caps and midcaps. And it contains 6,500 stocks, not 4,500 stocks.
Many investors have heard of the Russell 2000 Index. That is a good alternative for a small cap stock index. That is because the Index is constructed by taking the 2,000 stocks that fall below the 1,000 largest publicly traded companies.
Finally, another alternative is the newest small cap index, known as the S & P 600 Index. It holds fewer, but larger, companies than the Russell 2000 Index.
Each of these indexes offers unique benefits. Investors seeking broad market exposure should consider them as attractive alternatives to the S & P 500 (and to the Nasdaq Composite).
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Sponsored by James J. Eccleston. This Web site contains material of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
Always consult an attorney and/or investment adviser when building and protecting your wealth.
All content Copyright © 2010 Advocate Compliance Partners, Inc. except where noted. All rights reserved.
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