S&P 500 index funds: not diversified enough

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jhsu802701
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S&P 500 index funds: not diversified enough

Post by jhsu802701 »

Why are S&P 500 index funds so popular in the Boglehead community given the heavy concentration in certain individual stocks? Isn't diversification a core part of the Boglehead philosophy?

One thing I insist on when looking for a stock fund is diversification. Given that I don't have control, I insist on good diversification to mitigate the company-specific and industry-specific risks. If one of the stocks turns out to be the next Enron, Sears, Hertz, General Motors, Kodak, or other money-losing stock, it doesn't cause excessive damage to the portfolio. (I'm willing to sacrifice some diversification if I have assurance that the portfolio has high-quality stocks. A fund that specializes in dividend growth stocks or moat stocks is an example.)

In this thread, I'll apply the same approach I used to picking international stock ETFs for picking large cap US stock ETFs. I'll be using the figures from etf.com, because I like their ETF search tool. I'm still bearish on large cap US stocks and bullish on international stocks, but that's not the subject of this thread.

VOO has 6.35% of its portfolio in its biggest position (Apple) and 26.97% of its portfolio in the top ten positions. VOO is selling for 4.02 times book value.

Here are my large cap US stock ETF alternatives to the S&P 500:
* RDVY (First Trust Rising Dividend Achievers ETF): 2.31% in the biggest position, 22.10% in the top ten positions, 1.86 times book value
* QDIV (Global X S&P 500 Quality Dividend ETF): 1.78% in the biggest position, 17.07% in the top ten positions, 1.90 times book value
* EQAL (Invesco Russell 1000 Equal Weight ETF): 0.68% in the biggest position, 4.66% in the top ten positions, 2.26 times book value
* COWZ (Pacer U.S. Cash Cows 100 ETF): 2.45% in the biggest position, 21.49% in the top ten positions, 2.37 times book value
* RSP (Invesco S&P 500 Equal Weight ETF): 0.26% in the biggest position, 2.48% in the top ten positions, 2.64 times book value
* EQWL (Invesco S&P 100 Equal Weight ETF): 1.31% in the biggest position, 11.69% in the top ten positions, 2.55 times book value
* JPUS (JPMorgan Diversified Return U.S. Equity ETF): 0.58% in the biggest position, 4.85% in the top ten positions, 3.01 times book value
* NOBL (ProShares S&P 500 Dividend Aristocrats ETF): 2.67% in the biggest position, 19.06% in the top ten positions, 3.22 times book value
* GSEW (Goldman Sachs Equal Weight U.S. Large Cap Equity ETF): 0.26% in the biggest position, 2.35% in the top ten positions, 3.29 times book value

Note that all of the above funds have a lower price/book ratio than the S&P 500 but have superior diversification. The stocks in these portfolios are of similar or better quality than those in the S&P 500. I've omitted funds with under $50 million in assets under management due to the risk of closure.
DFJ: Japan - small cap dividend | DGS: emerging, small cap dividend | MOTI: international moat stocks | IQIN: large cap, developed | DGRE: emerging, dividend growth | GWX and FNDC: small cap, developed
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Re: S&P 500 index funds: not diversified enough

Post by 000 »

Why don't you list the ER of those funds? :twisted:

Also, I don't think P/B is a good valuation metric for picking funds.
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Re: S&P 500 index funds: not diversified enough

Post by Marseille07 »

Do you understand what you're talking about? NOBL is a subset of S&P500. If S&P500 isn't diversified enough, NOBL cannot be an alternative.
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Re: S&P 500 index funds: not diversified enough

Post by MishkaWorries »

000 wrote: Mon Jan 18, 2021 6:33 pm Why don't you list the ER of those funds? :twisted:

Also, I don't think P/B is a good valuation metric for picking funds.
I'm thinking of tilting to value for the same reason as OP. But his first choice RDVY has an ER of .50 and a concentration of 34% in financials and 33% in Information Technology. The S&P is only 27% Information Technology.

That ER is too high and the fund is not diversified enough.
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Re: S&P 500 index funds: not diversified enough

Post by anon_investor »

Why not VTI + VXUS and chill?
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Re: S&P 500 index funds: not diversified enough

Post by Halicar »

Look at a chart comparing the performance of VFIAX (S&P 500) with VTSAX (total US) and you'll see they are virtually identical.
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Re: S&P 500 index funds: not diversified enough

Post by sailaway »

The SP 500 isn't diverse enough so you buy SP 100?

Have you considered a bogleheads portfolio?
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Re: S&P 500 index funds: not diversified enough

Post by Marseille07 »

Also, I don't think the OP understands the intent of those ETFs. VOO for example tracks the S&P 500 - it doesn't have to carry the same underlying as how the index is calculated, so long as it can track the index. Therefore, this "concentration" talk is irrelevant.
Last edited by Marseille07 on Mon Jan 18, 2021 6:51 pm, edited 1 time in total.
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Re: S&P 500 index funds: not diversified enough

Post by bck63 »

You're worried that the S&P 500 isn't diversified enough, so you're going to invest in the 100 stock of EQWL? It doesn't make sense. I'm not sure why having the 100 stocks be equal weighted negates the fact that you're using 400 fewer stocks.

I own the S&P 500. I own 500 of the biggest and best companies in the world. Who wouldn't want to own such an investment?
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Re: S&P 500 index funds: not diversified enough

Post by Triple digit golfer »

What you're saying is artibrary. Amazon is one corporation and they are involved in retail, online shopping, streaming, web services, cloud computing, e-commerce, artificial intelligence, pharmacy, and who knows what else.

Why would you think having equal amount in Amazon and Joe's Hot Dogs is more diversified than having much more in Amazon and much less in Joe's Hot Dogs?

If something disrupts the hot dog industry, Joe's is toast.

If something disrupts retail or online shopping or streaming or web services or cloud computing or e-commerce or artificial intelligence or pharmacy, Amazon has many other product lines to pick up the slack. Amazon is more, hmm, what should we call it? Oh, I know! Diversified!
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Re: S&P 500 index funds: not diversified enough

Post by nisiprius »

People in this forum have thought about the question of diversification before. It is not perfectly simple; in fact I would say that the concept of "diversification" is some of the most heavily discussed general topics (another being "risk.")

Relatively few indexers here use S&P 500 index funds, by the way--most of us prefer total stock market index funds. It doesn't actually matter much. The S&P 500 was clearly intended to represent the total market at the time it was created, with concessions to limited computing power; and when it was created it actually included more than 90% of the market by cap weight.

In any case, whether total market indexers are wise or foolish most of us are aware of the composition of the stock market, and have probably glanced at the "ten largest stocks" list for any mutual fund we invest in.

Talking about diversification is not very interesting unless you define what you mean by diversification and also define what goals you expect to achieve with it.

Sometimes people suggest that diversification reduces risk, as measured by decline in a market crash, or volatility as measured by standardization. I am going to go down your list and find the first one that has been around enough to see how it did during the global financial crisis. I don't know how it's going to turn out. What I expect is that the decline will, in fact, be just about the same as for these "more diversified" funds as for an S&P 500 or a total market index fund; that is, the supposed superior diversification wouldn't have made much difference.

Well, we cannot know how RDVY, QDIV, EQAL, COWZ, JPUS, NOBL, or GSEW would have fared during the financial crisis as they did not exist, but RSP and EQWL did. So here is how RSP and EQWL did during the financial crisis, compared to SPY (S&P 500 ETF) and VTI (total market ETF).

Source

Image

As you see, they all fell by about 50%. The cap-weighted S&P 500 and total market index funds fell almost the same amount, -51%. One of your "more diversified" funds indeed fell less, -45%. But the other one fell more, -56%.

The S&P 500 index was intended to be a reasonable approximation to the total market at the time it was created--in fact it included 90% of total market cap at the time. Thus both the S&P 500 and total market indexes try to mirror the "market portfolio," the set of all stocks available in the stock market. Jeremy Siegel, in Stocks for the Long Run, writes:
To be sure, capitalization-weighted indexes have some very good properties. First, as noted earlier in the chapter, these indexes represent the average dollar-weighted performance of all investors, so that for anyone who does better than the index, someone else must do worse. Furthermore, these portfolios, under the assumptions of an efficient market, give investors the "best" trade-off between risk and return. This means that for any given risk level, these capitalization-weighted portfolios give the highest returns; and for any given return, these portfolios give the lowest risk. This property is called mean-variance efficiency.
The issue can and is argued, but sane people can and do choose to invest in total market index funds, and not because we are ignorant of the composition of the stock market. It is not clear that departing from the market does increase "diversification." And it is not clear just what departing from the market is really going to achieve.

It is not obvious to me that you have found nine funds that are better than a total market index fund.
Last edited by nisiprius on Mon Jan 18, 2021 7:17 pm, edited 1 time in total.
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Re: S&P 500 index funds: not diversified enough

Post by Marseille07 »

Focusing on the underlying is silly because it says nothing about the intent of an ETF. VOO can hold bitcoin and still track the S&P 500.
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Re: S&P 500 index funds: not diversified enough

Post by jhsu802701 »

Here's my list of large cap US stock ETFs WITH the expense ratios added:
* RDVY (First Trust Rising Dividend Achievers ETF): 2.31% in the biggest position, 22.10% in the top ten positions, 1.86 times book value, 0.50% ER
* QDIV (Global X S&P 500 Quality Dividend ETF): 1.78% in the biggest position, 17.07% in the top ten positions, 1.90 times book value, 0.20% ER
* EQAL (Invesco Russell 1000 Equal Weight ETF): 0.68% in the biggest position, 4.66% in the top ten positions, 2.26 times book value, 0.20% ER
* COWZ (Pacer U.S. Cash Cows 100 ETF): 2.45% in the biggest position, 21.49% in the top ten positions, 2.37 times book value, 0.49% ER
* RSP (Invesco S&P 500 Equal Weight ETF): 0.26% in the biggest position, 2.48% in the top ten positions, 2.64 times book value, 0.20% ER
* EQWL (Invesco S&P 100 Equal Weight ETF): 1.31% in the biggest position, 11.69% in the top ten positions, 2.55 times book value, 0.25% ER
* JPUS (JPMorgan Diversified Return U.S. Equity ETF): 0.58% in the biggest position, 4.85% in the top ten positions, 3.01 times book value, 0.18% ER
* NOBL (ProShares S&P 500 Dividend Aristocrats ETF): 2.67% in the biggest position, 19.06% in the top ten positions, 3.22 times book value, 0.35% ER
* GSEW (Goldman Sachs Equal Weight U.S. Large Cap Equity ETF): 0.26% in the biggest position, 2.35% in the top ten positions, 3.29 times book value, 0.09% ER

All of the above funds are better diversified than the S&P 500. If Apple and Microsoft disappoint investors, and the prices of those two stocks decline, these funds would not be affected as much as the S&P 500 would be. The fact that the S&P 500 has a greater number of stocks than the above funds do would not change the impact of Apple and Microsoft.

From the responses here, it seems that most people here believe that the biggest stocks (like Apple, Microsoft, Amazon, and Facebook) can do no wrong. History shows that no stock can be bulletproof forever. Remember that there were times when it was assumed that IBM, General Electric, Cisco Systems, HP, Sears, General Motors, and Kodak could do no wrong. Apple and Microsoft can do well but still disappoint investors. All it takes is for earnings to fall a few pennies short of expectations.

There are a number of international stock ETFs that I decided against buying into because the portfolios had too much riding on the top position.

The expense ratios of the funds I listed are higher than those of Vanguard funds, but they're not outlandish. Remember that there are bond mutual funds out there with higher expense ratios. 6 of the 9 funds I listed have expense ratios of 0.25% or less. While I consider a rock bottom expense ratio to be essential for bond and money market funds (because there's less variation from one security to another), it's not as essential for stock funds. There's a graph of expense ratios over time at https://www.bankrate.com/investing/what ... nse-ratio/ . I think some of you are so spoiled by the low expense ratios at Vanguard that everything else looks like highway robbery. Given that expense ratios are lower than they used to be and that differences from one fund to another have shrunk, this issue is less important than it used to be.
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Re: S&P 500 index funds: not diversified enough

Post by Marseille07 »

I don't think you understand what people are saying or how ETFs work. The underlying doesn't matter so long as an ETF is achieving its objective. In fact, if concentration actually mattered then VOO wouldn't be tracking S&P500 long ago.
Last edited by Marseille07 on Mon Jan 18, 2021 9:00 pm, edited 2 times in total.
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Re: S&P 500 index funds: not diversified enough

Post by vineviz »

jhsu802701 wrote: Mon Jan 18, 2021 8:46 pm I think some of you are so spoiled by the low expense ratios at Vanguard that everything else looks like highway robbery. Given that expense ratios are lower than they used to be and that differences from one fund to another have shrunk, this issue is less important than it used to be.
My philosophy is that spending 25bps on a fund is silly if the same objective can be accomplished for 6bps or less.
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Re: S&P 500 index funds: not diversified enough

Post by nisiprius »

jhsu802701 wrote: Mon Jan 18, 2021 8:46 pm...If Apple and Microsoft disappoint investors, and the prices of those two stocks decline, these funds would not be affected as much as the S&P 500 would be...
Although that sounds plausible, how do you explain the fact I showed above: that in 2008-2009, RSP, with only 0.2% each allocated to Apple and Microsoft, dropped farther than SPY and VTI?
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Re: S&P 500 index funds: not diversified enough

Post by 000 »

Why use these expensive funds instead of mixing in a low cost mid- or small-cap index?

VB costs 5 basis points...
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Re: S&P 500 index funds: not diversified enough

Post by nisiprius »

Another example. 2018-2019. Source for COWZ, RSP, EQWL, JPUS and similarly for others.

Maximum drawdowns (declines), 1/1/2018 through 12/31/2019

ProShares S&P 500 Dividend Aristocrats -8.74%
JPMorgan Diversified Return US Eq ETF -12.38%
Invesco S&P 100 Equal Weight ETF -12.64%
SPDR S&P 500 ETF Trust -13.52%
Invesco S&P 500 Equal Weight ETF -13.90%
Goldman Sachs Equal Wght US Lg Cp Eq ETF -14.39%
Invesco Russell 1000 Equal Weight ETF -15.47%
First Trust Rising Dividend Achiev ETF -15.59%
Global X S&P 500 Quality Dividend ETF -15.97%
Pacer US Cash Cows 100 ETF -16.73%

Average decline of jhsu802701's nine funds: -13.98%

So, of these funds, selected because jhsu802701 feels they are "more diversified" than the S&P 500:
  • three declined less than the S&P 500 ETF,
  • but six declined more;
  • The average decline of the nine ETFs was -13.98%, virtually identical to that of SPY (worse than SPY but only microscopically)
So while it sounds plausible in a hand-waving sort of way that reducing the weight of the largest stocks seems like it ought to stabilize performance, the observed fact is that it didn't in 2018-2019 and it didn't in 2008-2009.

It's really hard to improve on the characteristics of a total market index fund. Many of us start out thinking that index funds are plainly stupid and there is a whole list of obvious ideas for improvement that have just got to work. It isn't as easy as it seems.
Last edited by nisiprius on Mon Jan 18, 2021 10:22 pm, edited 2 times in total.
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Re: S&P 500 index funds: not diversified enough

Post by Steve Reading »

Marseille07 wrote: Mon Jan 18, 2021 6:51 pm VOO for example tracks the S&P 500 - it doesn't have to carry the same underlying as how the index is calculated, so long as it can track the index.
Sure, it doesn’t have to hold the same assets as the underlying index. But it actually does so why does the distinction matter?
Marseille07 wrote: Mon Jan 18, 2021 7:15 pm Focusing on the underlying is silly because it says nothing about the intent of an ETF. VOO can hold bitcoin and still track the S&P 500.
Maybe it could. But it doesn’t so who cares?
Marseille07 wrote: Mon Jan 18, 2021 8:55 pm I don't think you understand what people are saying or how ETFs work. The underlying doesn't matter so long as an ETF is achieving its objective. In fact, if concentration actually mattered then VOO wouldn't be tracking S&P500 long ago.
VOO will track the S&P 500 regardless of whether the concentration in the top 10 of the S&P 500 is a danger or not.

I don’t think I follow what you’re saying. I understand what everyone else has said (high fees, funds that are even more concentrated than VOO performing worse, etc) but not your comments.

Can you dumb it down for me?
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Re: S&P 500 index funds: not diversified enough

Post by Marseille07 »

Steve Reading wrote: Mon Jan 18, 2021 9:57 pm
Marseille07 wrote: Mon Jan 18, 2021 6:51 pm VOO for example tracks the S&P 500 - it doesn't have to carry the same underlying as how the index is calculated, so long as it can track the index.
Sure, it doesn’t have to hold the same assets as the underlying index. But it actually does so why does the distinction matter?
Marseille07 wrote: Mon Jan 18, 2021 7:15 pm Focusing on the underlying is silly because it says nothing about the intent of an ETF. VOO can hold bitcoin and still track the S&P 500.
Maybe it could. But it doesn’t so who cares?
Marseille07 wrote: Mon Jan 18, 2021 8:55 pm I don't think you understand what people are saying or how ETFs work. The underlying doesn't matter so long as an ETF is achieving its objective. In fact, if concentration actually mattered then VOO wouldn't be tracking S&P500 long ago.
VOO will track the S&P 500 regardless of whether the concentration in the top 10 of the S&P 500 is a danger or not.

I don’t think I follow what you’re saying. I understand what everyone else has said (high fees, funds that are even more concentrated than VOO performing worse, etc) but not your comments.

Can you dumb it down for me?
I don't think there's much to add, we're on the same page as far as I can see.
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Re: S&P 500 index funds: not diversified enough

Post by asset_chaos »

The heirarchy of stock fund concentration as measured by percent in largest companies goes

growth index > S&P 500 > total US market > total world

If current stock index fund is too concentrated for you to sleep well at night, move stock investment to the right until calm returns. If calm still remains elusive, move some stock investment into bonds until calm returns.
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Re: S&P 500 index funds: not diversified enough

Post by chem »

original poster,

You may also be interested in FNDX and DSTL as alternatives to strictly market-cap weighted US funds. There was some discussion of them in a similar thread:
viewtopic.php?p=5743223#p5743223

DSTL in particular is quite interesting for its FCF-based methodology while accounting for intangible assets. Also check out uncorrelated's post history for discussions of alternatives to market-cap weighting, in particular for portfolio management.

If you want to keep life simple, adding some RSP into your portfolio keeps you in the S&P while lessening portfolio market-cap weighting if you're concerned about regression among the top-X stocks. Good luck.
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Re: S&P 500 index funds: not diversified enough

Post by Actin »

The classic "pick the flowers and water the weeds" investing approach
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Re: S&P 500 index funds: not diversified enough

Post by Ferdinand2014 »

asset_chaos wrote: Tue Jan 19, 2021 12:16 am The heirarchy of stock fund concentration as measured by percent in largest companies goes

growth index > S&P 500 > total US market > total world

If current stock index fund is too concentrated for you to sleep well at night, move stock investment to the right until calm returns. If calm still remains elusive, move some stock investment into bonds until calm returns.
I’d say that about sums it up. We can make it complicated or simple. I prefer simple.
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Re: S&P 500 index funds: not diversified enough

Post by secondopinion »

000 wrote: Mon Jan 18, 2021 9:18 pm Why use these expensive funds instead of mixing in a low cost mid- or small-cap index?

VB costs 5 basis points...
So true; people should look at inexpensive small- and mid-cap funds first if they are really concerned about concentration risk (remember, equal weight funds will have a lower average cap in general so why worry). I do not hold either the S&P or total market; I elected to split the total market to control that concentration risk by holding a little more small and mid-caps than market-weight would dictate. I do not like putting all my funds in a handful of companies either; it can be done cheaply if one accepts imperfection in the method. It will also have less turnover as well than an equal-weight.
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Re: S&P 500 index funds: not diversified enough

Post by Tamales »

An interesting visual comparison can be had using Stockcharts.com's 'perf chart" tool.
This is RSP vs SPY vs VTI
https://stockcharts.com/freecharts/perf ... y%2C%20vti
I think you can do this without a subscription (someone without a subscription please post whether you can do the below comparison).

If you drag the window size handle (at the bottom of the chart it shows x days, and you can click and drag the handle on this label to the left) so that the full range it shows is 4463 days, then use the SHIFT+Right Arrow keys to cycle the starting dates (zero point) of the charts through today, it's interesting to see how these trade places at the final value, over time.

At the bottom of the financial crash, in march 2009, the equal weight outpaces SPY and VTI for a couple months, but by may of 2009 it is behind again, and stays that way for over a decade. Maybe there's something to this 'coming off a bottom' point,but note that coming off the bottom of the pandemic in march 2020, the equal weight again pulls ahead, then the 3 exchange places several times. What this comparison will look like a year or two from now is anyone's guess, but I thought it was an interesting dynamic comparison.
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Re: S&P 500 index funds: not diversified enough

Post by Makefile »

jhsu802701 wrote: Mon Jan 18, 2021 8:46 pm Here's my list of large cap US stock ETFs WITH the expense ratios added:
* RDVY (First Trust Rising Dividend Achievers ETF): 2.31% in the biggest position, 22.10% in the top ten positions, 1.86 times book value, 0.50% ER
* QDIV (Global X S&P 500 Quality Dividend ETF): 1.78% in the biggest position, 17.07% in the top ten positions, 1.90 times book value, 0.20% ER
* EQAL (Invesco Russell 1000 Equal Weight ETF): 0.68% in the biggest position, 4.66% in the top ten positions, 2.26 times book value, 0.20% ER
* COWZ (Pacer U.S. Cash Cows 100 ETF): 2.45% in the biggest position, 21.49% in the top ten positions, 2.37 times book value, 0.49% ER
* RSP (Invesco S&P 500 Equal Weight ETF): 0.26% in the biggest position, 2.48% in the top ten positions, 2.64 times book value, 0.20% ER
* EQWL (Invesco S&P 100 Equal Weight ETF): 1.31% in the biggest position, 11.69% in the top ten positions, 2.55 times book value, 0.25% ER
* JPUS (JPMorgan Diversified Return U.S. Equity ETF): 0.58% in the biggest position, 4.85% in the top ten positions, 3.01 times book value, 0.18% ER
* NOBL (ProShares S&P 500 Dividend Aristocrats ETF): 2.67% in the biggest position, 19.06% in the top ten positions, 3.22 times book value, 0.35% ER
* GSEW (Goldman Sachs Equal Weight U.S. Large Cap Equity ETF): 0.26% in the biggest position, 2.35% in the top ten positions, 3.29 times book value, 0.09% ER

All of the above funds are better diversified than the S&P 500. If Apple and Microsoft disappoint investors, and the prices of those two stocks decline, these funds would not be affected as much as the S&P 500 would be. The fact that the S&P 500 has a greater number of stocks than the above funds do would not change the impact of Apple and Microsoft.
Hey,

The Boglehead philosophy is about taking advantage of what an index fund can do--match the performance of the whole stock market, less the costs of running the fund. This requires building your own personal 'scale model' of the whole stock market by buying every stock in the same proportion it exists in the whole market. To hold 5% or so of your US position in Apple is the cost of admission to achieve US market-matching returns.

These "equal weight" funds reject that proposition. I would argue they are not index funds at all--the worst of both worlds, not mirroring a selected slice of the market without trying to second-guess it, yet not actively managed by a stock picker attempting to beat the market either--and really don't make any sense. Sorry.

Now, you are getting onto something however. Some investors on here do make a conscious choice to hold something different than the total market. They might do a "mid/small-cap tilt" by holding 70% 500 Fund and 30% Extended Market fund rather than the 84/16 or so combination that would create the Total Market. They might do a "value tilt" by holding Vanguard Growth Index and Vanguard Value Index in their chosen proportions. But they are still assembling their portfolio from a collection of market-cap-weighted index funds. I would suggest running your proposed allocation to those ETFs in something like Morningstar Instant X-Ray to see if you're anywhere near the whole market.

You do have two valid criticisms of S&P 500 however. To index the US market one should buy Total Stock Market Index Fund--that's in John Bogle's last book Stay the Course, which I would suggest reading as it explains these ideas in a much better way. It even covers an example of a company that attempted and abandoned the "equal weight" strategy in the 1970s that those ETFs are reinventing today.

The second criticism is that an all-S&P 500 portfolio obviously excludes international stocks.

You may well be right that these huge companies could underperform in the future, and it certainly is possible an equal weighted fund could outperform. But using those is a conscious choice to reject matching the total market and to build a portfolio with no logical connection to it.
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