The S&P 500 is intended to be an index of 500 large companies listed on stock exchanges in the United States. However, if you take a closer look, you’ll find that just 10 stocks—or 2 percent of the total 500—account for almost one-third of the index’s overall performance. Why does this happen, and why should you care? Let’s take a closer look.
The S&P 500 is a Weighted Average
At first glance, it may seem like the S&P is an equal representation of 500 different stocks, but that’s not how it works. The index is actually a weighted average, so larger companies drive a more significant proportion of the index’s performance than relatively smaller companies. As the largest companies continue to grow ever larger, the market is becoming increasingly concentrated. This causes a dramatic lack of diversification, which can be financially catastrophic.
1999 was the last time we saw statistics similar to this. At the height of the dot-com bubble, excessive investments in Internet-related companies led to an inflated market rise. In March 2000, the NASDAQ Composite rose 400 percent, only to fall 78 percent—or $5 trillion—by October 2002, negating all the gains experienced during the bubble. The dot-com crash also caused countless Internet startups to fail.
How to Ensure Portfolio Diversification
The issue of poor diversification lurks beneath the surface of many portfolios, particularly these days, given the massive run-up of a small handful of companies driving a disproportionately high segment of the market. The media has labeled these companies the “FANGs” because they comprise Facebook, Amazon, Netflix, and Google, among others.
Clearly, when it comes to diversifying your portfolio, it’s not enough merely to own index funds. You really need to dig deeper and see what percentage of your portfolio is constituted in your top 10 holdings, which shows you what you ultimately own.
With the way things are right now, index funds may be comprised of the same kinds of companies. Remember, the top 10 holdings in any portfolio should never exceed about 20 percent of the portfolio’s total value. And if your top 10 holdings begin to exceed 30 percent, your portfolio is not nearly as diversified as it should be.
To sum up, it’s vitally important to be aware of the impact of investing in the S&P. If you’re not careful, you could end up with a serious lack of diversification, even when you think you’re diversifying effectively by investing in an index fund. For help digging into your portfolio and optimizing your investments, please contact Nelson Financial Planning. We’ll help you change your life with a successful financial plan.
As a financially savvy individual, you know you should be investing and preparing for retirement. Everyone wants to build a healthy nest egg, but what if you don’t have any extra cash or disposable income each month? These are two major roadblocks to investing. Another is buying a house while making sure you don’t end up “house poor.”
Problems with Rushing into Buying a House
The way you go about buying a house can dramatically impact the amount of money you have leftover at the end of the month. Spending too much on a mortgage or rushing into the wrong opportunity can cause two major issues:
- You rack up debt: If you put all your money into buying a house, you may end up taking out loans or putting day-to-day expenses on credit cards without the ability to pay them off. Going into debt just to make ends meet is never a good place to be financially.
- You have no disposable income to invest in: Because of inflation, money is always more valuable today than it will be tomorrow. As a result, you should strive to always keep your funds growing through wise, diversified investments.
A Look at Florida Homebuyers
Radio show host, author, and businessman Dave Ramsey recommends keeping housing expenses around 25 percent of your income. Following this advice, a Floridian earning the state’s median household income of $53,000 should spend no more than $13,500 per year—or $1,100 per month—on housing.
However, the average American spends about 37 percent of their income on housing. This means a typical Floridian might spend nearly $20,000 per year—or over $1,600 per month—on rent or a mortgage. This is a difference of roughly $6,000 per year.
Putting Your Money to Work for You
$6,000 per year might not sound significant, but this amount can substantially affect your investment portfolio. $6,000 is enough to fully fund a traditional or Roth IRA. You can use $6,000 per year to fund your children’s college educations in a 529 college savings plan. Or you can put $6,000 into stocks and bonds as a personal investment. The possibilities are endless!
Assuming a 7 percent rate of return, investing $6,000 per year starting at age 25 can grow to over $1.2 million by the time you reach retirement age, or 65 years old. However, if you spend an excessive amount of your income on housing and don’t have anything left to invest, you will not end up with the same nest egg when you retire.
Clearly, it’s essential to understand the opportunity cost of buying a house, especially if doing so will push your housing expenses too high. For more on how we can help you determine if a mortgage is within your budget, please contact Nelson Financial Planning. Our team of certified financial fiduciaries focuses every day on helping you change your life through a successful financial plan that provides peace of mind for the future.