VTSAX not diversified enough?

[cincystache]

Forgive me if this has been asked before but I couldn't readily find a similar thread...

I have almost all of my US stock exposure in the form of VTSAX (or the equivalents SCHB, VTI, FSKAX) based on simplicity/JL collins book etc.

With the recent surge in tech stocks I now see that the top 7 tech stocks (AAPL, MSFT, AMZN, FB, GOOG, NVDA, TSLA) comprise over 22% of the portfolio. While I'm thankful for the boost in performance, I'm starting to feel a little concentrated in one sector/size company. I thought the whole philosophy of VTSAX is not being concentrated in too few companies. 

Does anyone branch out and divide their US allocation evenly into Large, Mid, Small cap funds to get a more even distribution? How about splitting further into growth and value funds as well as market cap so having 4-6 funds with equal amounts instead of 1 fund? I used to argue that the complexity and/or added cost wasn't worth it but when I think about it, it only takes 5 minutes per year to rebalance everything back to even and the expense ratio differences between these funds is almost zero.

Does this concern anyone else or am I overthinking things and I should keep plowing into VTSAX?

[jamesbond007]

VTSAX is a market cap weighted fund. So naturally, as of now, those stocks take up much of the share. I am sure back when XOM had the highest market, it would have been in AAPL's position today. It has 3500 stocks in its portfolio, so it is the entire market. In my view, it can't get any more diversified that it. I believe the only thing missing from VTSAX are Bonds and Real Estate and of course international stocks. Look at the other side, if those 6 stocks tank, then there is a much bigger problem :)

[Radagast]

I looked into this here:
https://forum.mrmoneymustache.com/investor-alley/portfolio-design-idiots-v-gurus/

Generally, I support your suspicion that at least a three fund portfolio is needed, and I like four or more, at the very least one of the Vanguard balanced funds which contain four funds but are as easy to manage as one fund . My perpetual advice is:
At least 50% stocks
Not more than 50% US or other single country/currency stocks
10-40% bonds/cash
Include international stocks at ~20-50% of stock holdings
A real asset, possibly a house, or several is nice, especially coming up on ER. But don't forget business is the main driver of long term returns and the main protection against long term downside risk. As long as people are prospering, and they probably will be, you want a big part of that.

[joleran]

I have had a major small cap tilt for many years due to these concerns, not much of a value tilt though.  I weight small cap and mid cap each at roughly 80% of large cap.  (as a somewhat interesting aside - somehow personal capital thinks I am very overweight mid cap growth compared to mid cap value despite not owning any growth-specific funds)

This of course has not done well for me in the last 5 years or so, but changing now would be performance chasing.  If you are considering doing a tilt, this is probably a relatively great time to do so if it ever does turn out to pay off.

[Telecaster]

Does anyone branch out and divide their US allocation evenly into Large, Mid, Small cap funds to get a more even distribution? How about splitting further into growth and value funds as well as market cap so having 4-6 funds with equal amounts instead of 1 fund? I used to argue that the complexity and/or added cost wasn't worth it but when I think about it, it only takes 5 minutes per year to rebalance everything back to even and the expense ratio differences between these funds is almost zero.

Does this concern anyone else or am I overthinking things and I should keep plowing into VTSAX?

That's reasonably close to the way I do it.  There is some good evidence that equal weight beats cap-weight over sufficiently long periods of time.  There are a few ways to look at it, but be warned it is rabbit hole once you start.  That said, an 60/40 blend of VOO/VO gives you essentially an equal weighted S&P 500 index fund.  Or you could just buy RSP, which is S&P equal weight ETF (but at a slightly higher expense ratio).   QQQE is Nasdaq equal weight, if you'd like to consider that.  Then buy a jigger of small cap if you like (maybe 10% of the total) and another jigger of international and you are pretty well diversified. 

Warning! If you had followed this strategy over the last few years you would be lagging VTSAX.  So consider that.

[Buffaloski Boris]

Short answer: in my opinion yes. Putting 20% plus of a portfolio into 6 or 7 stocks is a bad idea in my view. Take it one step further and look at what the top 50 or so stocks in VTSAX comprise. There are equal weight alternatives such as RSP.  And lots of international alternatives.

[ChpBstrd]

IDK, to diversify out of VTSAX/VTI and its tech stocks, one would have to invent and believe a very specific narrative about how the market has mispriced certain assets and the future will turn out in a specifically different way than the average investment dollar thinks, such as:

“The stock market has overestimated how much of the future world economy will be comprised of activities by these seven companies, and therefore as the truth becomes apparent, the value of these shares will decline relative to the value of all other shares.”

Does this seem like too bold of a bet to put six figures on the line? Would it be a leap of logic to take this same rationale and convince yourself to short the tech large caps?

[joleran]

IDK, to diversify out of VTSAX/VTI and its tech stocks, one would have to invent and believe a very specific narrative about how the market has mispriced certain assets and the future will turn out in a specifically different way than the average investment dollar thinks, such as:

“The stock market has overestimated how much of the future world economy will be comprised of activities by these seven companies, and therefore as the truth becomes apparent, the value of these shares will decline relative to the value of all other shares.”

Does this seem like too bold of a bet to put six figures on the line? Would it be a leap of logic to take this same rationale and convince yourself to short the tech large caps?

There is a big difference between a position of "these companies are a larger part of my portfolio than I would like, so I will diversify company (and antitrust!) risk without particular expectation of increased or decreased returns as a result" and "these companies will underperform".

[nereo]

For a historical perspective, most of our current mantra of "diversify" stems from the days before low-cost index funds and when a person's entire portfolio might consist of 6-20 individually picked stocks.  Until index funds and discount brokerages came on the scene, it was cost-prohibitive for most individual investors to own more than this.

Is VTSAX diversified enough? Depends on what you are going for.  As noted, it's a market-cap weighted index, which means the top ten companies will be worth more than the bottom 2,000+.  But here's the rub... the very reason why Facebook or Amazon holds such a massive position relative to, say, HR Block is because it is WAAAAY more important to the overall economy.  Amazon has a quarter of a trillion in sales and over a million workers.  HR Block does does about $4B in business and hires 90k mostly seasonal workers.
If your goal is for your portfolio to reflect the broader economy, which holding should be worth more?

Or to repeat what @ChpBstrd said... what reason(s) do you have for changing your holdings to reflect something not representive of the economy?  You can absolutely to increase holdings of some sector or of smaller companies, but you should be clear about the reasons why.
Holding a bond fund, for example, has some very obvious, well researched reasons.  Deciding you want more small cap companies at the expense of very large companies which employ millions (e.g. Apple, Amazon, Microsoft)... well ... why?

[solon]

The point of VTSAX is to mimic the total US stock market. So whatever happens to be going on in the larger market is what you'll find happening in the fund. Right now AAPL, MSFT, AMZN, FB, GOOG, NVDA, and TSLA are major companies, but will they still be in ten years? If not, which companies will be big in ten years? Since we can't know, we invest in VTSAX, which mimics the entire market, and as the market slowly changes so will the fund.

I think it's beautiful, and it's exactly what I want. I wouldn't change it.

[Buffaloski Boris]

Holding a bond fund, for example, has some very obvious, well researched reasons.  Deciding you want more small cap companies at the expense of very large companies which employ millions (e.g. Apple, Amazon, Microsoft)... well ... why?

I can think of several reasons. First, single company risk doesn’t go away just because a company is big. That’s doubly true when the company is monstrous and a target of antitrust efforts both domestically and abroad. Given that our domestic politicians are reliable lapdogs for the .1%, I doubt that the antitrust efforts domestically will come to much. Overseas it’s a different outlook and that’s where a lot of the revenue for these companies come from.

Second, these very megacap companies have relatively rich PE ratios as compared to the mean. Said another way, there is a whole lot of optimism about these companies compared to the average large company. Is it merited? Unknown, but I’m skeptical. My admittedly subjective view is that companies don’t have as big of competitive moats as they wish they had. So investors are likely overestimating that future earnings stream.

Third, and this is the huge one for me personally, is that it’s not only important to diversify a domestic stock portfolio, it’s also important to invest across asset classes, countries, and currencies. Given that most of us are Americans, investing solely in the US market is unnecessarily risky. It’s a bet primarily on the US economy and more importantly on the US dollar. Why indeed! Do we all think that the US economy will be stronger relative to other world economies for the foreseeable future? Do we think that the dollar will remain the preeminent currency indefinitely? Even if we do, are we willing to put essentially all of our assets in the dollar given that our incomes AND assets AND homes are all denominated in that currency?

For some people, that answer is yes. And I wish them the best of luck.

[nereo]

The point of VTSAX is to mimic the total US stock market. So whatever happens to be going on in the larger market is what you'll find happening in the fund. Right now AAPL, MSFT, AMZN, FB, GOOG, NVDA, and TSLA are major companies, but will they still be in ten years? If not, which companies will be big in ten years? Since we can't know, we invest in VTSAX, which mimics the entire market, and as the market slowly changes so will the fund.

I think it's beautiful, and it's exactly what I want. I wouldn't change it.

To wit:
(companies which had not previously been a #5 company ever indicated in BOLD)
Top 5 companies in 1970:
GM, Exxon, Ford, GE, IBM

Top 5 companies in 1980:
IMB, AT&T, Exxon, Standard Oil & Schlumberger

Top 5 companies in 1990:
IMB, Exxon, GE, Philip Morris, Royal Dutch Petrol,

Top 5 companies in 2000:
GE, Exxon Mobil, Pfizer, Citigroup, Cisco Systems

Top 5 companies in 2010:
Exxon Mobile, Apple, Microscoft, Berkshire Hathaway, GE

Top 5 companies today:
Apple, Microsoft, Amazon, Facebook, Alphabet


... for the last five decades a new company has entered into the 'most vaiuable' category (and many have fallen.  Schlumberger is now in the bottom half. GM is now ranked 147th (previously #1).  IBM - formerly a top-5 for 30+ years - is now worth about 4% of Apple.

[nereo]

Holding a bond fund, for example, has some very obvious, well researched reasons.  Deciding you want more small cap companies at the expense of very large companies which employ millions (e.g. Apple, Amazon, Microsoft)... well ... why?

I can think of several reasons.

Thanks for your detailed response. 
Just to be clear it was something for the OP to think about. 
I'm not against checking the holdings to weight different sectors or market-caps differently.  But I think people get lost quickly when they hear the mantra "Diversify!" and then learn that Apple makes up almost 7% of their total holdings, and large banks like Morgan Stanley at just a fraction of 1%.  So they rush to 'correct' this by buying a small-cap fund or a non-weighted fund or by beefing up bank stocks so they have the same holdings as tech companies.  Only they don't fully appreciate that 'technology stocks' dominate the indicies precisely because they employ the most people and have the most assets and make the most money.

Full disclosure:  I've tweaked my own asset allocation (AA) moderately to hold a few sectors that are important to me and to increase international exposure in developed economies... though more than half of my equities are still in an SP500 fund.

[theoverlook]

... for the last five decades a new company has entered into the 'most vaiuable' category (and many have fallen.  Schlumberger is now in the bottom half. GM is now ranked 147th (previously #1).  IBM - formerly a top-5 for 30+ years - is now worth about 4% of Apple.

And, as the "most valuable" company changes, the holdings in the index have changed. I don't see the problem.

Antitrust as has been mentioned also isn't a big issue to me. If the company is broken up, you get to keep your shares of the new companies and that's sometimes worked out very well for investors. Either way if they fade the amount held in the index will fade.

[MustacheAndaHalf]

Although the S&P 500 is the most famous S&P index, there's also a broad index called the S&P 1500 with mid- and small-cap stocks.  Over the long term, the S&P 1500 does tend to beat active funds.  But I found it interesting that in both 2003 and 2009, their broad market index beat less than half of active funds:
2003, right after the dot-com crash (beat 48.0% of active funds)
2009, right after the 2008 financial crisis (beat 40.7% of active funds)
https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2018.pdf

Interesting, but not much in the way of evidence.  Back to the long-term, that same report shows the returns of U.S. mutual funds versus the S&P 1500 over the 10 years that followed the 2008 Financial crisis.. S&P 1500 gained 13.2%/year while the rest of the U.S. mutual funds gained 11.5%.  So the long term still favors holding a broad index fund.