“S&P and Chill” is the least diversified it has ever been.

Mega-cap companies have begun to make up increasingly large portions of the S&P 500 and Nasdaq 100. Before we get into it, I want to make everyone aware of what a market cap-weighted index is. Both the S&P 500 and the Nasdaq 100 are market-cap weighted indices. This means that the larger a company, the more weight it is given in the index.

As of recent, mega-caps, such as Apple, Nvidia, and Microsoft have exploded upwards. Each of them boasts a total market cap of over $3T. That is 12 zeros that follow the 3. $3,000,000,000,000…

Now these companies carry massive weight in the indices given their size. Below are a couple of screen clips from slickcharts.com:

I spoke recently about concentration risk. These 3 companies account for over 21% of the S&P 500 and over 25% of the Nasdaq 100. That is not nearly as diversified as one may think.

I’ll add this, momentum usually makes people even more bullish on individual names. We are starting to hear flurries of “too big to fail” when it comes to these 3 names. Now, do I think these companies will fail? Not at all. But could there be a massive sell-off in one of these names? Duh. Did you forget 2022? Apple declined 27.6% from its high, Microsoft declined 35.5% and Nvidia declined 66%.

People constantly spew the idea of an S&P 500 ETF being the immediate and ultimate diversifier. However, it is getting harder and harder to make that claim. If you were to say an S&P 500 ETF was a great way to diversify amongst large-cap US-listed companies… I wouldn’t disagree but even that could become a stretch if these companies add more weight. 

Make no mistake, I am not saying the S&P 500 is a bad investment, nor am I encouraging anyone not to invest. I am just claiming that the S&P 500 is not NEARLY as diversified as one may think.

Now, what makes the S&P 500 such an amazing index and such a great way for passive investors to gain exposure to large-cap stocks is its weighting. It adds to the winners and kicks out the losers. All without you having to even think about it.

When we think of diversified portfolios, we think of large-caps, mid-caps, small-caps, international developed equities, emerging market equities, and fixed income or bonds. True diversification is an incredibly useful tool when it comes to investing.

International exposure can at times be counter-cyclical to US-based markets. This can dampen a blow if US stocks take a downturn. Fixed income can dampen volatility and even offer opportunities with the potential for rate hikes down the line.

I have left a few charts below that illustrate mid-cap performance and how international stocks can be counter-cyclical to US markets.

When you’re truly diversified, you will always be underperforming the best-performing asset class in your portfolio. This is one of the aspects of diversification that isn’t fun, but in a downturn, volatility can be dampened by owning multiple asset classes, which is a great feeling.

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