I suppose it’s all in how you look at it. Certainly there are times when companies with a smaller market cap have beaten the top 25 in the SP500. But the SP500 is market weighted by design. Apple, Google and MS are worth over 6T collectively and directly employ about 500k people. Their quarterly revenue eclipses the bottom third. Companies like Alaskan Airlines are worth less than 1/500th of Apple.
Sure, you could hold all 500 companies and give equal weight to each (each company would be about 0.2% of your total portfolio)… but that’s not increasing your diversification. Your volatility would almost certainly go way up too, as smaller companies can have much greater swings.
It definitely increases your diversification. Your dollars are spread more evenly across the field instead of being concentrated in fewer companies with similar characteristics. That is the definition of diversification. Now, you may not
want that. But you are indeed getting more diversification.
Since you've already started drilling down to individual companies in the index, let's take it a bit further. The Big Seven tech companies have an average P/E of about 40, compared to the rest of the index which is about 18. Several of those companies had P/E in the teens just a few years ago, so they've gotten much more expensive over the last few years. Same for other metrics like P/S. Is concentrating your portfolio in high P/E companies good diversification?
Exactly. There's always all this hand-wringing about subjects that are intrinsically how indices work. You can't complain about the SP500 being dominated by a few large cap stocks, because it's by definition a market cap weighted index. It will always be dominated by large cap companies. That's by design.
It is indeed by design, but the S&P 500's design has nothing to do with investing. The S&P 500 index was created to describe leading industries in a format simple enough it could be calculated once per hour. This replaced predecessor indices that included smaller numbers of stocks that were calculated once per day, or even once per week. Investing in the S&P 500 index wasn't even possible for another couple decades after it was created.
I think it is entirely reasonable, prudent in fact, to examine the idea there might be improvements to the OG index in the decades that followed. And in fact, Standard & Poor created an equal weight S&P 500 index about 20 years ago,
which has outperformed the OG index since that time. This is a post-discovery finding, so the results are compelling. But S&P's backtest to 1990 showed even more outperformance. And others have backtested equal weight even farther and on other indices like the NASDAQ and
Wilshire 5000 which resulted in similar outperformance of about 1-2% over any reasonably long period of time.
To be 100% clear, I think the traditional "fire and forget" advice of putting in VTSAX and not looking back is great advice. I've never discouraged anyone from doing that. The opposite in fact. But it doesn't follow there aren't good logical reasons why other strategies are worthwhile too.
