Heresy: is using a SP500 index still a valid strategy ?

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Ready.Fire.Aim
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Heresy: is using a SP500 index still a valid strategy ?

Post by Ready.Fire.Aim » Wed Jul 25, 2018 11:20 pm

How can a 3-Fund Portfolio investment strategy using a SP500 index fund ( VINIX) still be valid with only ten companies (FAANGS) dominating market earnings?

No longer is risk of loss spread amongst a broad pool of 500 companies in different sectors; changes in a few companies or a single sector ( technology) significantly affects the index. Thus changes in a few results in greater volatility.

Thus a key benefit of a stock index fund from risk diversification is greatly diminished.


Personal Perspective for context:

I've been using Vanguard index funds with satisfaction for 25+ years, I stayed 70/30 in 2000 and 2008 and did well in the long run as the stock side nicely rebounded.

However, this spring 2018 I transitioned from a three fund portfolio to a fixed income and bond portfolio yielding avg 2.7% until I gain a personal comfort level with these atypical market conditions.

I just retired in April, had been concerned our retirement plans were vulnerable to sequence of return risks with a FANGS dominated stock portfolio. Eliminating VINIX allowed me to sleep better.
I'm fortunate to have living expense needs met with a pension and the 2.7% return allows all of our retirement plans to be fulfilled.

I don't expect these conditions to last more than 2 or 3 years and do plan to transition back into SP500 index fund assuming a reversion to the historical mean.

Although I never posted, I've been a Bogleheads forum reader for several years ( not a troll) and have purchased & read the Bogleheads books.

Thanks,
RFA

Reference:
https://www.bloomberg.com/news/articles ... half-gains

"David Kostin, chief U.S. equity strategist at Goldman Sachs, highlighted that more than 100 percent of the S&P 500’s total return of nearly 3 percent in the first half is attributable to just 10 equities. Amazon.com Inc. alone accounts for roughly two-fifths of the benchmark gauge’s advance"

AlohaJoe
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by AlohaJoe » Wed Jul 25, 2018 11:53 pm

Ready.Fire.Aim wrote:
Wed Jul 25, 2018 11:20 pm
Reference:
https://www.bloomberg.com/news/articles ... half-gains

"David Kostin, chief U.S. equity strategist at Goldman Sachs, highlighted that more than 100 percent of the S&P 500’s total return of nearly 3 percent in the first half is attributable to just 10 equities. Amazon.com Inc. alone accounts for roughly two-fifths of the benchmark gauge’s advance"
Why do you ignore the part of the article that says
Of course, it’s not unusual for a fairly small number of stocks to deliver the lion’s share of gains in indexes weighted by market capitalization
and provides a link to an article that goes into even more detail about how totally normal this is
It is true that a few stocks bailed out the cap-weighted index last year. But it’s also true in most years. It’s always directionally true, that’s just math, and in 2015 it was true by just about the average amount.
You wrote
No longer is risk of loss spread amongst a broad pool of 500 companies in different sectors; changes in a few companies or a single sector ( technology) significantly affects the index. Thus changes in a few results in greater volatility.
Your beliefs about the past composition of S&P 500 returns are not correct.

tibbitts
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by tibbitts » Thu Jul 26, 2018 12:12 am

Ready.Fire.Aim wrote:
Wed Jul 25, 2018 11:20 pm
How can a 3-Fund Portfolio investment strategy using a SP500 index fund ( VINIX) still be valid with only ten companies (FAANGS) dominating market earnings?
I'm not sure the situation today is as atypical as you believe, but your response wasn't to buy the rest of the domestic equity market (or even a higher percentage of international index funds, which you apparently continue to hold) instead, it was to replace domestic equities with bonds?

Ari
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by Ari » Thu Jul 26, 2018 12:52 am

As has already been pointed out:

1. It's not an atypical situation, just business as usual. It's pretty much mathematically certain that in a cap-weighted index where some companies are much larger than others, and some companies are doing much better than others, then the section "large companies that are doing well" is going to have huge earnings. If you instead start from the smallest companies that are doing well, you could have a headline saying "These 300 companies make up 100% of the S&P500 earnings" and it would leave out all of the FAANG stocks and be equally true.

2. A reasonable response to "I'm worried I'm overexposed to a handful of stocks in the S&P500" is to buy small/midcaps or to increase your international exposure. Selling all of your equities (including your international equities!) is not reasonable.

I think you need to examine this behavior, as you're wildly overreacting to inconsequential data coming from the financial media. Not having a lot of equities is probably a good thing for you, but 0% equities is pretty much never a good idea. There may be a significant risk that once the media writes something about how stocks are historically a bargain based on some obscure metric, you'll suddently increase your equity exposure and have it crash on you.
All in, all the time.

Theoretical
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by Theoretical » Thu Jul 26, 2018 12:58 am

Yes, for several reasons. One, it's a bargain basement cheap way to access US stocks. Costs matter. Two, even with the FAANGs, you've still got plenty of other conglomerates in the picture. It's not like some countries where one stock is 40% of the market cap. Three, the correlation between different grades of US stocks means it's "good enough" to get you general US stock exposure.

I say all of this as a very heavy small value tilter that doesn't trust the FAANG or even more the .com type stocks like Tesla, and who tilts regardless of whether the premia is positive or negative ex-ante to take single stock risk to a bare minimum.

a5ehren
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by a5ehren » Thu Jul 26, 2018 10:27 am

The response to this concern is to replace VFINX with VTSAX or add a small/mid tilt, not to sell all your equities.

deltaneutral83
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by deltaneutral83 » Thu Jul 26, 2018 10:52 am

So as of the end of Q1 FAANG represented 11% of the S&P, so the other 89% is chopped liver? Good news, FB has decided reduce it's stake :oops:. Buy the haystack to get the needle, the needle will move around frequently though over the years and I know I don't know where it's located other than inside the haystack.
Last edited by deltaneutral83 on Thu Jul 26, 2018 10:55 am, edited 1 time in total.

MotoTrojan
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by MotoTrojan » Thu Jul 26, 2018 10:54 am

How many times expenses do you have?

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nisiprius
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by nisiprius » Thu Jul 26, 2018 11:03 am

1) In this forum, the most-commonly-suggested core stock holding is not an S&P 500 index fund, and it hasn't been in the time I've been following the forum, say 2007 or so. It has been a total market index fund: the Vanguard Total Market Index Fund (VTSMX, VTSAX, VTI) or any of a number of similar funds from other companies (Fidelity Total Market Index Fund, FSTMX; Schwab Total Market Index Fund, SWSTX; the ITOT ETF; etc.)

2) Yes, new investors often do not realize that the composition of the stock market is skewed, just like the composition of many other things. The stock market has always dominated by the largest companies in the market.

It's where investors as a group have decided, based on the same information available to you, to put most of their money.

"Is still" are the kinds of words used by a salesperson. Instead of saying "you were following a stupid strategy," which might annoy you, they say "My goodness, you certainly were clever to follow that strategy, which use to be a terrific strategy. You certainly must be well-informed. I'll bet you get all romantic partners you want. However, you need to ask: is it still a valid strategy?"

3) Your decision whether or not to index shouldn't be based on what the composition of the market happens to be now. It is always changing. It should be whether or not to hold a replica of the "market portfolio," the entire set of stocks available for exchange in the stock market. There are good reasons for wanting to do that, based on financial economics--and founded on assumptions that may or may not be approximately true. But if it ever makes sense to do it, it always makes sense to do it.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

acegolfer
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by acegolfer » Thu Jul 26, 2018 12:24 pm

nisiprius wrote:
Thu Jul 26, 2018 11:03 am
3) Your decision whether or not to index shouldn't be based on what the composition of the market happens to be now. It is always changing. It should be whether or not to hold a replica of the "market portfolio," the entire set of stocks available for exchange in the stock market. There are good reasons for wanting to do that, based on financial economics--and founded on assumptions that may or may not be approximately true. But if it ever makes sense to do it, it always makes sense to do it.
Does "market portfolio" include ex-US equity? AFAIK, US equity accounts for less than 50% of the global equity.

MichCPA
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by MichCPA » Thu Jul 26, 2018 1:12 pm

Having a small group of stocks make up all of your gains is just proof that it is hard to pick specific stocks. I look at your point as its own counterfactual. If you own the haystack, you own all of the needles in the haystack.

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verbose
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by verbose » Thu Jul 26, 2018 1:24 pm

I use the 500 index in my 401k because it’s the only low-cost US equity index offered.

I balance it with Vanguard Extended Market Index in my IRA.

rterickson
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by rterickson » Fri Jul 27, 2018 3:13 pm

verbose wrote:
Thu Jul 26, 2018 1:24 pm
I use the 500 index in my 401k because it’s the only low-cost US equity index offered.
+1

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Pajamas
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by Pajamas » Fri Jul 27, 2018 3:49 pm

Ready.Fire.Aim wrote:
Wed Jul 25, 2018 11:20 pm
However, this spring 2018 I transitioned from a three fund portfolio to a fixed income and bond portfolio yielding avg 2.7% until I gain a personal comfort level with these atypical market conditions.

I just retired in April, had been concerned our retirement plans were vulnerable to sequence of return risks with a FANGS dominated stock portfolio. Eliminating VINIX allowed me to sleep better.
I'm fortunate to have living expense needs met with a pension and the 2.7% return allows all of our retirement plans to be fulfilled.

I would question your motivation for this being trying to time the market but that said, it sounds like you don't have any need to take risk, so why take it, now or in the future?

If being 100% in fixed income and bonds allows you to cover all of your future financial needs and sleep well at night, it sounds like it might be fine for you to stay out of equities forever.

See this thread:

viewtopic.php?t=163863

jalbert
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by jalbert » Fri Jul 27, 2018 4:28 pm

I don't expect these conditions to last more than 2 or 3 years and do plan to transition back into SP500 index fund assuming a reversion to the historical mean.
You may never again see the S&P500 valued at your exit point. You also may be taking substantial inflation risk if your portfolio is 100% nominal bonds and cash. Inflation risk is invisible, bear markets are not, so we fear the latter more, but both are significant risks for a retiree.

Sequence of return risk (market is low and only recovers after substantial withdrawals at the low valuation), inflation risk, and longevity risk are the three most significant risks for a retiree. Being 100% nominal bonds addresses sequence of return risk, but not the other two risks unless your portfolio value is high enough to cover them with excess portfolio value relative to your expenses to be covered.
Index fund investor since 1987.

ignition
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by ignition » Fri Jul 27, 2018 4:31 pm

Why did you stay the course in 2000? Valuations were a lot more ridiculous back then compared to now.

Also I think it's always smart to have a little in stocks, even as little as 25% should help and minimize regret if stocks continue to rally.

Ready.Fire.Aim
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by Ready.Fire.Aim » Sat Jul 28, 2018 12:15 am

Pajamas wrote:
Fri Jul 27, 2018 3:49 pm
If being 100% in fixed income and bonds allows you to cover all of your future financial needs and sleep well at night, it sounds like it might be fine for you to stay out of equities forever.

See this thread:

viewtopic.php?t=163863
Thank you for the link, it provided perspective I had not considered. Taylor Larimore had good insight in the thread.

MotoTrojan wrote:
Thu Jul 26, 2018 10:54 am
How many times expenses do you have?
Investment portfolio is 46X expenses, earning avg 2.7%.
However all our living expenses and medical insurance are fully met by my corporate pension with 15% to spare.
We are using investment to offset inflation on fixed pension, travel, grandchildren future college, and church + charity.

All major expenses ( i.e. roof, A/C, new windows, 2 new vehicles, furniture, remodeling) were reset immediately prior to retiring, plus debt free for 20 years.


ignition wrote:
Fri Jul 27, 2018 4:31 pm
Why did you stay the course in 2000? Valuations were a lot more ridiculous back then compared to now.
Stayed 80% stocks in 2000 and 2008, I knew enough to ride it out and not sell for a huge loss. In 2008 I invested heavier in stocks when the market was depressed, plus I was still working earning a great salary.

April 1, 2018 I retired, my priority for a portfolio has shifted to preserving capital ( offsetting inflation) rather than taking more risk to increase wealth. My current savings fully meet my long term needs.

Thus the concern with sequence of return impact from a major market reversal. Probability & consequence ( risk) appears high due to FAANGS domination of the stock index's earning & valuations.

ignition
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by ignition » Sat Jul 28, 2018 6:01 am

Ready.Fire.Aim wrote:
Sat Jul 28, 2018 12:15 am
ignition wrote:
Fri Jul 27, 2018 4:31 pm
Why did you stay the course in 2000? Valuations were a lot more ridiculous back then compared to now.
Stayed 80% stocks in 2000 and 2008, I knew enough to ride it out and not sell for a huge loss. In 2008 I invested heavier in stocks when the market was depressed, plus I was still working earning a great salary.

April 1, 2018 I retired, my priority for a portfolio has shifted to preserving capital ( offsetting inflation) rather than taking more risk to increase wealth. My current savings fully meet my long term needs.

Thus the concern with sequence of return impact from a major market reversal. Probability & consequence ( risk) appears high due to FAANGS domination of the stock index's earning & valuations.
But there is no sequence of return risk. All your expenses are covered by your pension. Even if you have no pension and keep a 50/50 portfolio, you have enough in bonds to cover 23 years of living expenses. You can cover a stock market crash lasting 23 years (even not taking into account your pension). Of course you don't need any stocks anymore as your expenses are covered, but it seems overly prudent and you're probably leaving a lot of money on the table.

If your plan is to wait 2-3 years for a reversion to the mean, as a boglehead you should know this is market timing and it rarely works out. But who knows, you might get lucky.

indexonlyplease
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by indexonlyplease » Sat Jul 28, 2018 6:21 am

Pajamas wrote:
Fri Jul 27, 2018 3:49 pm
Ready.Fire.Aim wrote:
Wed Jul 25, 2018 11:20 pm
However, this spring 2018 I transitioned from a three fund portfolio to a fixed income and bond portfolio yielding avg 2.7% until I gain a personal comfort level with these atypical market conditions.

I just retired in April, had been concerned our retirement plans were vulnerable to sequence of return risks with a FANGS dominated stock portfolio. Eliminating VINIX allowed me to sleep better.
I'm fortunate to have living expense needs met with a pension and the 2.7% return allows all of our retirement plans to be fulfilled.

I would question your motivation for this being trying to time the market but that said, it sounds like you don't have any need to take risk, so why take it, now or in the future?

If being 100% in fixed income and bonds allows you to cover all of your future financial needs and sleep well at night, it sounds like it might be fine for you to stay out of equities forever.

See this thread:

viewtopic.php?t=163863
I
'm fortunate to have living expense needs met with a pension and the 2.7% return allows all of our retirement plans to be fulfilled.

This is a great point Pajamas makes in his post. You won and your fixed plan pays the bills you are good. When and if the market drops you will be happpy you have more fixed income to pay the bills. It is really easy for all of us in this market to want a highter AA in stocks. I am sure many will change after a market correction.

I did the some changes also close to retirement. Went form 100 percent stock funds 2 years before retiremtent(2014) with a 60/40 AA. Then in retirement(2016) went 50/50 AA. So I am happy with being in more fixed income. I also have pension that covers all everything I need. So I have not touch investments yet. I could be in high AA but I figure why. I am sure as time goes on I will even lower my stock AA.

Enjoy your retirement.

ignition
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by ignition » Sat Jul 28, 2018 8:50 am

indexonlyplease wrote:
Sat Jul 28, 2018 6:21 am
This is a great point Pajamas makes in his post. You won and your fixed plan pays the bills you are good. When and if the market drops you will be happpy you have more fixed income to pay the bills. It is really easy for all of us in this market to want a highter AA in stocks. I am sure many will change after a market correction.

I did the some changes also close to retirement. Went form 100 percent stock funds 2 years before retiremtent(2014) with a 60/40 AA. Then in retirement(2016) went 50/50 AA. So I am happy with being in more fixed income. I also have pension that covers all everything I need. So I have not touch investments yet. I could be in high AA but I figure why. I am sure as time goes on I will even lower my stock AA.

Enjoy your retirement.
To be honest I think it's more likely that bonds won't hold their value over the next 20 years than stocks at current rates/valuation.

michaeljc70
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by michaeljc70 » Sat Jul 28, 2018 9:31 am

"until I gain a personal comfort level with these atypical market conditions."

What metrics will you use for that? It sounds very subjective, emotional and exactly the kind of thing that will get you in trouble. What if the market rallies 20% from here? What if it rallies 40% without a major pullback? Are you comfortable sitting on the sidelines barely keeping pace with inflation? There have been plenty of discussions on market timing.

As others have pointed out, picking the S&P 500 and this FAANG stuff sounds like an excuse rather than rational reasoning.

financeperchance
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by financeperchance » Sat Jul 28, 2018 1:47 pm

These were the top 10 S&P 500 companies in 1980:
http://etfdb.com/history-of-the-s-and-p-500/#1980

financeperchance
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by financeperchance » Sat Jul 28, 2018 2:27 pm

Just to expand on my post just now, someone in 1980 could have easily said almost the same thing, but I have highlighted the one change you would have made:

"No longer is risk of loss spread amongst a broad pool of 500 companies in different sectors; changes in a few companies or a single sector (oil) significantly affects the index."

And suppose you even had a crystal ball that told you that IBM, GE, and Ma Bell would greatly decline over the next 3-4 decades relative to the rest of the index.

Would it have been a mistake to invest in the S&P 500 vs. taking a more active approach? Of course not! You still would have outperformed almost everyone.

jalbert
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by jalbert » Sat Jul 28, 2018 4:53 pm

How can a 3-Fund Portfolio investment strategy using a SP500 index fund ( VINIX) still be valid with only ten companies (FAANGS) dominating market earnings? 
As long as you have stayed the course, you owned those companies before they dominated the market, but it is unlikely you would have known to pick them. Owning the whole market ensures you owned today's dominant stocks before they were dominant, and ensures you own the next group of dominant stocks before they are dominant.
Index fund investor since 1987.

gmaynardkrebs
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by gmaynardkrebs » Sat Jul 28, 2018 10:54 pm

ignition wrote:
Sat Jul 28, 2018 8:50 am
indexonlyplease wrote:
Sat Jul 28, 2018 6:21 am
This is a great point Pajamas makes in his post. You won and your fixed plan pays the bills you are good. When and if the market drops you will be happpy you have more fixed income to pay the bills. It is really easy for all of us in this market to want a highter AA in stocks. I am sure many will change after a market correction.

I did the some changes also close to retirement. Went form 100 percent stock funds 2 years before retiremtent(2014) with a 60/40 AA. Then in retirement(2016) went 50/50 AA. So I am happy with being in more fixed income. I also have pension that covers all everything I need. So I have not touch investments yet. I could be in high AA but I figure why. I am sure as time goes on I will even lower my stock AA.

Enjoy your retirement.
To be honest I think it's more likely that bonds won't hold their value over the next 20 years than stocks at current rates/valuation.
TIPS are guaranteed to hold their value.

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whodidntante
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by whodidntante » Sat Jul 28, 2018 11:24 pm

You have to construct an index somehow. The stocks in the s&p 500 are chosen by a committee, with some guidelines for quality, market cap, public float, and liquidity, and then it is float weighted. That's fine and really cheap to implement. There are other ways to construct an index if you prefer something else (and I do). We argue about the right way to do it fairly often.

ignition
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by ignition » Sun Jul 29, 2018 3:48 am

gmaynardkrebs wrote:
Sat Jul 28, 2018 10:54 pm
ignition wrote:
Sat Jul 28, 2018 8:50 am
indexonlyplease wrote:
Sat Jul 28, 2018 6:21 am
This is a great point Pajamas makes in his post. You won and your fixed plan pays the bills you are good. When and if the market drops you will be happpy you have more fixed income to pay the bills. It is really easy for all of us in this market to want a highter AA in stocks. I am sure many will change after a market correction.

I did the some changes also close to retirement. Went form 100 percent stock funds 2 years before retiremtent(2014) with a 60/40 AA. Then in retirement(2016) went 50/50 AA. So I am happy with being in more fixed income. I also have pension that covers all everything I need. So I have not touch investments yet. I could be in high AA but I figure why. I am sure as time goes on I will even lower my stock AA.

Enjoy your retirement.
To be honest I think it's more likely that bonds won't hold their value over the next 20 years than stocks at current rates/valuation.
TIPS are guaranteed to hold their value.
I'm talking about nominal bonds obviously. I don't see the OP mentioning TIPS.

SGM
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by SGM » Sun Jul 29, 2018 4:06 am

I have never been out of the market in 40 years of investing. Cash accounts are almost guaranteed not to keep up with inflation. I consider cash accounts risky for that reason.

Market timing rarely beats leaving your money in the market.

The S&P 500 performance has always been heavily influenced by the top holdings. I have taken that to be axiomatic.

jminv
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Re: Heresy: is using a SP500 index still a valid strategy ?

Post by jminv » Sun Jul 29, 2018 5:21 am

A small proportion of stocks (~4%) have always been responsible for the vast majority of market gains. These stocks change over time. This is the point in holding an index since it's difficult to know out of the universe of publcily listed companies out there which ones will give you this growth and which ones will be duds or implode. Actively trying to avoid companies that might provide you these returns would be self-defeating.

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