It\u2019s the basis of the classic index fund. It\u2019s the core holding in legions of portfolios and the proxy for the U.S. market. But the
\n S&P 500
\n isn\u2019t really a diversified index anymore: The \u201cBig Seven\u201d technology companies in it account for nearly 30% of its entire market capitalization.<\/p>\n
Investors in a plain-vanilla S&P 500 index fund have done well this year, but the gains aren\u2019t what they seem: Most of the strength is thanks to
\n Apple
\n (ticker: AAPL),
\n Microsoft
\n (MSFT),
\n Alphabet
\n (GOOGL),
\n Amazon.com
\n (AMZN),
\n Nvidia
\n (NVDA),
\n Tesla
\n (TSLA), and
\n Meta Platforms
\n (META).<\/p>\n
\n
\u201cThe S&P 500 is essentially a large-cap growth fund, for all intents and purposes, just by the way market-cap weighting works,\u201d says Ben Carlson, director of institutional asset management at Ritholtz Wealth Management. <\/p>\n
Rather than providing exposure to a diversified basket of 500 companies, the index\u2019s megacap-tech concentration poses considerable risk if there is another tech bubble fueled by artificial intelligence. Its two biggest holdings\u2014Apple and Microsoft\u2014alone account for 14% of the index.<\/p>\n
\u201cU.S. stock market performance has increasingly been driven by just a few companies that all share similar market cap, sector exposure, and valuations,\u201d wrote Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management. \u201cRather than providing a true defense, the clustering of performance could leave investors\u2019 portfolios less diversified than they might think.\u201d<\/p>\n
Here\u2019s a sobering stat: Half of the expected S&P 500 earnings growth in the fourth quarter of 2023 will come from just four companies, according to FactSet. In its June 9 Earnings Insight report, the firm found that four percentage points of the 8.2% expected fourth-quarter index earnings growth comes from Meta, Nvidia, Alphabet, and Amazon. Without these stocks, S&P earnings growth in the final quarter of the year is estimated to be 4.2%.<\/p>\n
A small subset of big stocks dominating the ups and downs of the S&P 500 is nothing new, says Dougal Williams, chief wealth officer at Vista Capital Partners, a registered investment advisor that manages $2.2 billion in client assets. \u201cHistorically, the performance of the biggest stocks has lagged behind after they\u2019ve become the biggest,\u201d he says. \u201cTheir performance is stellar, of course, to help them arrive near the top, but once there, their future returns tend to underperform the market.\u201d<\/p>\n
The good news is that it has never been easier to diversify beyond the S&P 500, with asset managers adding to their lineup of low-cost exchange-traded funds with new strategies and offering low-cost versions of popular mutual funds.<\/p>\n
To capture the market\u2019s full potential return, here\u2019s what investment strategists recommend:<\/p>\n
Now is the time to invest overseas.<\/strong> \u201cInternational diversification, for the first time in almost two decades, is going to be very important to investors over the next 10 years\u2014and the next 12 months, for that matter,\u201d says Peter Lazaroff, CIO of Plancorp, a national registered investment advisor with about $6 billion of client assets.<\/p>\nHaving some foreign-stock exposure is a smart asset-allocation strategy\u2014and valuations are cheap overseas, so it\u2019s a good time to add that diversification. <\/p>\n
In a recent note, Vanguard said international stocks offer \u201ca good opportunity for U.S. investors to achieve higher relative returns, as the drivers of U.S. stock outperformance over the past decade have likely sown the seeds for their underperformance over the coming one.\u201d<\/p>\n
ETFs in the foreign large-blend category are good candidates to anchor a foreign-stock portfolio, while small- and mid-cap European stock funds can bolster exposure, according to Morningstar. <\/p>\n
The
\n Dimensional International Core Equity Market
\n ETF (DFAI) is an active ETF in the foreign large-blend category. For a passive ETF, consider
\n iShares Core MSCI Total International Stock
\n (IXUS),
\n Vanguard FTSE All-World ex-U.S. Index
\n (VEU), or
\n Vanguard Total International Stock Index
\n (VXUS).<\/p>\n
On the mutual fund side, Barron\u2019s<\/em> recently reported that
\n Brandes International Small Cap Equity
\n (BISAX) has had stellar performance this year, with a total return of 19.3%. It is ranked in the second percentile, meaning it has outperformed 98% of its category peers.<\/p>\nDon\u2019t give up on value investing.<\/strong> It has been a tough year for value stocks. A popular value ETF,
\n iShares S&P 500 Value
\n (IVE), is up about 11% this year, while its growth equivalent,
\n iShares S&P 500 Growth
\n (IVW), is up 20%.<\/p>\nVictoria Greene, CIO of G Squared Private Wealth, a boutique firm with about $560 million under management, says value stocks still deserve a place in a portfolio. \u201cWhenever the markets are signaling a mania, I like to look for parts of the market that are just a little bit steadier,\u201d she says. \u201cThese are higher-quality companies, and they\u2019re more defensive.\u201d<\/p>\n
In addition to the iShares S&P 500 Value ETF, which has an expense ratio of 0.18%, you can choose
\n SPDR Portfolio S&P 500 Value
\n (SPYV), with a rock-bottom expense ratio of just 0.04%;
\n Vanguard S&P 500 Value
\n (VOOV), with expenses of 0.1%; or
\n iShares Russell 1000 Value
\n (IWD) and
\n Vanguard Russell 1000 Value
\n (VONV), with fees of 0.18% and 0.08%, respectively.<\/p>\n
Find small companies with big prospects.<\/strong> \u201cHistorically, asset classes, winners and losers, go through cycles, and U.S. large-caps have been the winner since the [2008-09] financial crisis,\u201d says Plancorp\u2019s Lazaroff. \u201cThere is no one asset class that continues to win and win and win.\u201d <\/p>\nThat means it may be worth taking another look at the little guys. One ETF that Lazaroff likes for client portfolios is
\n Avantis U.S. Small-Cap Value
\n (AVUV). <\/p>\n
For a mutual fund, the Morningstar four-star-rated
\n Davenport Small Cap Focus
\n (DSCPX) has a solid record: Over five years, the fund is ranked in the first percentile, besting 99% of its category peers. This year it is up 12.5%, better than 93% of its peers.<\/p>\n
If you\u2019re wondering how to diversify across strategies and investment styles, Ritholtz\u2019s Carlson offers some advice: Find a target-date retirement fund that matches your expected retirement date and use that as your benchmark for asset allocation. \u201cThat\u2019s a pretty good benchmark for a well-diversified portfolio,\u201d he says. <\/p>\n
Write to <\/strong>Lauren Foster at lauren.foster@barrons.com<\/p>\n<\/p><\/div>\nRead the full article here<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"It\u2019s the basis of the classic index fund. It\u2019s the core holding in legions of portfolios and the proxy for the U.S. market. But the S&P 500 isn\u2019t really a diversified index anymore: The \u201cBig Seven\u201d technology companies in it account for nearly 30% of its entire market capitalization. Investors in a plain-vanilla S&P 500 […]<\/p>\n","protected":false},"author":1,"featured_media":32488,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"gallery","meta":{"footnotes":""},"categories":[241],"tags":[83],"class_list":["post-32487","post","type-post","status-publish","format-gallery","has-post-thumbnail","hentry","category-markets","tag-featured","post_format-post-format-gallery"],"yoast_head":"\n
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