How diversified is the S&P 500 Index?

The S&P 500 consists of 500 of the country’s largest publicly traded companies. These companies include the following sectors: energy, technology, consumer staples, consumer discretionary, financials, health care, industrial, materials, telecommunication, utilities and real estate. At first glance, this seems like adequate diversification. However, the S&P 500 is market cap weighted, which means that the larger companies make up a bigger percentage of the index than the smaller companies.

Technology companies currently make up about 25 percent of the entire index and the largest five tech stocks (Apple, Microsoft, Google Amazon and Facebook) accounted for 14.4 percent of the entire index as of the end of February 2018.

Since the beginning of 2015, the technology sector has returned 18 percent per year vs. 10.2 percent for the S&P 500 as a whole. This recent out-performance has contributed to the tech sector’s overweight in the index. What does this mean for the S&P 500? It means that if technology stocks continue outperform, then that bodes well for the S&P 500. However, if the sector falls out of favor, the S&P 500 will likely under-perform.

If you own the S&P 500 index or an actively managed large cap mutual fund, which on average consists of 30.3 percent technology, then you are essentially making an oversize bet on the technology sector.

If you would prefer to be a more diversified investor rather than an unwitting sector bettor, there are some viable alternatives. For instance, the Guggenheim S&P 500 equal weight index allows investors to own an equal share of all 500 stocks with quarterly rebalancing. For value investors, the Barclay’s Shiller Cape Index allows investors to own only the cheapest sectors of the S&P 500. This index has significantly performed the S&P 500 as a whole over the last five years with significantly less volatility.

Source: Barrons