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- Nov 27, 2014
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Was listening to a podcast today and the host made an interesting observation about diversification and index funds. He used the S&P as an example. Since you cannot but the index (it's a statistical model), we but an index that closely matches the index. In the S&P the stocks are weighted. Without getting into details, he stated the following:
The first 5 stocks make up about 12% of the S&P.
With the next 5 (top 10), you're up to about 20%
Another 10 (to 20) and you're at about 30%.
So while we think we have broad exposure to the market by following an index fund, the weighting distorts that. If you look at the top 5, Apple, Microsoft, Amazon, Facebook, Johnson and Johnson you're highly weighted on technology.
Another point he made is that as a ton of people have moved into index funds, this weighting causes the index fund managers to buy in a weighted manner which is somewhat of a momentum push for those stocks.
I thought it was interesting and his only conclusion was to look into the index you're buying and understand what stocks and what proportion you're actually buying.
I was wondering what the group thought of this and this also lead me to my next thought - should I concentrate my investments in an index fund which has a goal of tracking an index or, should I concentrate on good funds with a track record and goal of maximizing return based on an objective (thinking of Wellington and Wellesley).
The first 5 stocks make up about 12% of the S&P.
With the next 5 (top 10), you're up to about 20%
Another 10 (to 20) and you're at about 30%.
So while we think we have broad exposure to the market by following an index fund, the weighting distorts that. If you look at the top 5, Apple, Microsoft, Amazon, Facebook, Johnson and Johnson you're highly weighted on technology.
Another point he made is that as a ton of people have moved into index funds, this weighting causes the index fund managers to buy in a weighted manner which is somewhat of a momentum push for those stocks.
I thought it was interesting and his only conclusion was to look into the index you're buying and understand what stocks and what proportion you're actually buying.
I was wondering what the group thought of this and this also lead me to my next thought - should I concentrate my investments in an index fund which has a goal of tracking an index or, should I concentrate on good funds with a track record and goal of maximizing return based on an objective (thinking of Wellington and Wellesley).