Why is Apple so heavy in VTSAX?

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razeus
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Why is Apple so heavy in VTSAX?

Post by razeus » Tue Oct 27, 2015 8:22 am

Long lurker, first time poster.

I'm curious why my admiral shares of VTSAX has such a heavy weighting in Apple. I know it's an index fund, but should the companies be equal? Apple is like 3-4x the shares of everything else.

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Re: Why is Apple so heavy in VTSAX?

Post by Geologist » Tue Oct 27, 2015 5:06 pm

Vanguard's index funds (as are most) are weighted by market capitalization (number of shares times share price). Consequently, high market capitalization companies such as Apple are more of the index. Some people think indexes should be constructed a different way and some are, but that is not the way most are. One advantage of a market cap index fund is that it automatically re-balances as each company's share price fluctuates.

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Re: Why is Apple so heavy in VTSAX?

Post by Valuethinker » Tue Oct 27, 2015 5:25 pm

razeus wrote:Long lurker, first time poster.

I'm curious why my admiral shares of VTSAX has such a heavy weighting in Apple. I know it's an index fund, but should the companies be equal? Apple is like 3-4x the shares of everything else.
No.

The most common way is to weight by equity market capitalization

equity market cap = number of shares in issue x last closing price (usually). A measure of the value the stock market puts on a business at any given moment in time.

Otherwise you'd get weird anomalies. ACME Plumbing (market cap $10bn) would get the same value in the stock market as Apple (say $700bn market cap). Yet Apple is a company that makes far more sales and profits, and has (in the view of the market) better growth prospects.

Also if you equal weighted, then every time one company did better than another, you'd be forced to sell shares to reweight. That would incur large transactions costs and large capital gains distributions to the fund investors.

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Re: Why is Apple so heavy in VTSAX?

Post by LadyGeek » Tue Oct 27, 2015 7:40 pm

razeus, Welcome!

The wiki has some background info: Market capitalization

Also see: Why market cap matters (listed under the wiki's "External links" section.)
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Re: Why is Apple so heavy in VTSAX?

Post by sillysaver » Tue Oct 27, 2015 8:05 pm

It's interesting. There has been a lot of hype around equal-weighted indexes ("smart beta") lately.

Personal Capital manages stock portfolios with equal weightings. Guggenheim offers some equal-weighted funds.

As a consequence it is overweight small cap (relative to market indexes). It is also less exposed to any particular stock or industry. For risk reduction, that's great, but it is also inherently more volatile due to the small cap exposure.

It is more expensive to equally weight but proponents claim better performance.

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Re: Why is Apple so heavy in VTSAX?

Post by nisiprius » Tue Oct 27, 2015 8:09 pm

Razeus, there are pretty good and convincing reasons for wanting an index fund to be cap-weighted. Some of them go back to 1923 and Irving Fisher's work and his book, The Making of Index Numbers.

Because Vanguard has been so successful with its cap-weighted index funds, it is hard to compete with Vanguard directly. A swarm of rivals now try to compete with things that can be called "index funds" and thus benefit from the good reputation of indexing, but don't use cap-weighting so they can be claimed to be better. The result is that there is a drumbeat of critics all saying the same thing: cap-weighting sucks. And one of the commonest ways to attack it is to complain that it invests more money in the biggest companies.

That is to say, they complain about the fact that cap-weight index funds are cap-weighted! But they phrase in a way that makes it as if it's bad. It's sort of like the roofer who tried to convince me he was selling me superior shingles by saying that the competition's shingles had ground-up oyster shells in them. It was perfectly true. It's just that there's not a thing wrong with oyster shells, and he never said there was. Or like the joke-scare publications warning that your drinking water contains dihydrogen monoxide.

I don't mind being cap-weighted because I want to mirror the market, and the market itself is cap-weighted. The whole point of indexing is to shrug and accept the market's decisions on valuations and allocation. Not because the market is always right, it isn't by a long shot, but because it's right more often than I am. So, VTSAX puts 3.2% of my money into Apple stock. Why? Because the U.S. stock market itself puts 3.2% of its money in Apple stock. I don't know why the market wants to put so much of its money into Apple, but I don't care.

Now, you may want to look into the arguments for the competition, but just be careful and be aware that there are obvious financially-interested reasons why anyone who isn't Vanguard might want to knock cap-weighting.

Now if you want to invest equally in all of the 500 stocks of the S&P 500 there is an ETF that does that. I don't think it's a good idea, but of course there are those who do.
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Re: Why is Apple so heavy in VTSAX?

Post by David Jay » Wed Oct 28, 2015 12:12 am

nisiprius wrote:Or like the joke-scare publications warning that your drinking water contains dihydrogen monoxide.
Oh, noes !
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Re: Why is Apple so heavy in VTSAX?

Post by boglerdude » Wed Oct 28, 2015 12:31 am

Apple's P/E is 14, is it wise for index investors to be buying companies with P/Es 50+

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Re: Why is Apple so heavy in VTSAX?

Post by ogd » Wed Oct 28, 2015 1:24 am

boglerdude wrote:Apple's P/E is 14, is it wise for index investors to be buying companies with P/Es 50+
Yes. Using P/E for picking stocks, like many other measures, simply doesn't work.

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Re: Why is Apple so heavy in VTSAX?

Post by nisiprius » Wed Oct 28, 2015 6:25 am

ogd wrote:
boglerdude wrote:Apple's P/E is 14, is it wise for index investors to be buying companies with P/Es 50+
Yes. Using P/E for picking stocks, like many other measures, simply doesn't work.
???? I don't understand the point boglerdude is making here, because 14 isn't 50+, and 14 isn't usually considered to be nosebleed territory.[Explained by ogd, below, thanks]

But the thing is, in any case, of course it's wise for index investors to invest in the index. That's the choice we've made, that's our strategy. We do invest in companies with P/E ratios that are high, low, and in between. We put our money where the market puts its money.

And of course there are many, many people who think they can improve on that strategy by doing something or other to focus more on companies that are "undervalued" and less on companies that are "overvalued." Some do it by intuition. Some by deep study of the company's business. Some do it by assuming that some simple statistic that's routinely collected and published, like P/E, must be at least a rough indication of whether the company is likely to be undervalued or overvalued, and thus assume that a simple stock screen (like the ones most brokerages offer) will give you an edge over blindly indexing. Some advocate a more sophisticated combination of screening which at least one guru calls a "magic formula." Some advocate a modified weighting system, "fundamental indexing," that takes account of things other than the total amount of money the market has chosen to allocate to a stock. Some advocate "factors" and/or "smart beta."

What these all amount to is departures from cap-weighting by picking stocks or at least gently focussing on groups of stocks that are thought to be better than the market as a whole.

(Amazingly) the evidence that any of them is much better than cap-weighting is very slim. Since they are all different from cap-weighting, they all offer the "potential for" doing better than cap-weighted indexing--and, of course, for doing worse. And they all have had runs of time, sometimes long and impressive runs of time, during which they did much better than the market, and, usually, times when they did much worse (except that nobody writes about the strategies that are underperforming--and many of the more complicated strategies, particularly when implemented in an actual fund, are only a peek into a short period of time).

The point is: the market itself allocates its dollars by cap-weighting. Or to put it another way around, the definition of cap-weighting is that it is the way the market has voted, one vote per dollar.
Last edited by nisiprius on Wed Oct 28, 2015 8:32 pm, edited 1 time in total.
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Re: Why is Apple so heavy in VTSAX?

Post by 22twain » Wed Oct 28, 2015 10:37 am

David Jay wrote:
nisiprius wrote:Or like the joke-scare publications warning that your drinking water contains dihydrogen monoxide.
Oh, noes !
http://www.dhmo.org/facts.html
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Re: Why is Apple so heavy in VTSAX?

Post by CoolHobieCat » Wed Oct 28, 2015 11:12 am

When I compare VTSAX with the Schwab ETF, SCHB, there is not enough difference to make a difference. Please see for yourself.

https://www.portfoliovisualizer.com/bac ... sisResults

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Re: Why is Apple so heavy in VTSAX?

Post by ogd » Wed Oct 28, 2015 12:51 pm

nisiprius wrote:
ogd wrote:
boglerdude wrote:Apple's P/E is 14, is it wise for index investors to be buying companies with P/Es 50+
Yes. Using P/E for picking stocks, like many other measures, simply doesn't work.
???? I don't understand the point boglerdude is making here, because 14 isn't 50+, and 14 isn't usually considered to be nosebleed territory.
I believe boglerdude was saying that when stocks with P/E 14 exist (Apple), why would anyone buy stocks with P/E 50+ (others in the index, like Amazon some quarters). You and I are saying that picking by this or other measures doesn't seem to work, and stock picking is hard, certainly much harder than that. For example, in Amazon's case the high P/E is because of high capital investments, which demand different measures to be accounted for. Or, hidden in P/E 5 for another stock is the fact that the market believes the company is dying.
nisiprius wrote:The point is: the market itself allocates its dollars by cap-weighting. Or to put it another way around, the definition of cap-weighting is that it is the way the market has voted, one vote per dollar.
In addition to that, the other indisputable fact about cap-weighting is that it's the lowest turnover strategy that is still well-defined (i.e. same weighting now independent of the time you bought). Since turnover costs (spreads and taxes) are about the one sure thing in investing, it has a natural advantage that other strategies would have to overcome.

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Re: Why is Apple so heavy in VTSAX?

Post by Valuethinker » Wed Oct 28, 2015 12:52 pm

nisiprius wrote:
The point is: the market itself allocates its dollars by cap-weighting. Or to put it another way around, the definition of cap-weighting is that it is the way the market has voted, one vote per dollar.

Even if it were a better strategy to equal weight, the additional dealing costs would hurt performance.

And if you are in a taxable account, the additional taxes would most likely kill any advantage in the long run. A market cap weighted fund only sells when there is a change in index (a new company IPO'ing or a takeover, for example) or when there are investor inflows/ outflows. Whereas an equal weighted fund would be constantly buying and selling.

High turnover = > worse performance.

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Re: Why is Apple so heavy in VTSAX?

Post by Valuethinker » Wed Oct 28, 2015 12:55 pm

ogd wrote:For example, in Amazon's case the high P/E is because of high capital investments, which demand different measures to be accounted for.

Puzzled by this.

For a company growing its earnings as fast as it does, Apple has a *low* PE. The PE of 14x (prospective) recognizes the fact that Apple's earnings per share (the denominator) are growing very fast, thus justifying a high share price (the numerator). That's actually below the US stock market as a whole? (about 20.0x prospective?)

Does Apple have high capex? Amazon does (servers for AWS, warehouses and distribution assets etc.). Google does (servers). Apple doesn't own any production facilities? It presumably expenses its software and marketing expenses, not capitalizing and amortizing them?

High capex implies a high depreciation charge and thus lower earnings.

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Re: Why is Apple so heavy in VTSAX?

Post by telemark » Wed Oct 28, 2015 2:18 pm

The main advantage of indexing, as I see it, is that it's an easy, low cost way to diversify away the risk of owning individual stocks. But if a sizable portion of the index is concentrated in a small number of stocks, you start to lose that benefit. Perhaps the Russell 3000 is better described as the Russell 2990 + 10? I don't have a practical solution, other than to consider tilting to small cap, but that doesn't mean that it isn't a problem.

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Re: Why is Apple so heavy in VTSAX?

Post by ogd » Wed Oct 28, 2015 2:48 pm

telemark wrote:The main advantage of indexing, as I see it, is that it's an easy, low cost way to diversify away the risk of owning individual stocks. But if a sizable portion of the index is concentrated in a small number of stocks, you start to lose that benefit. Perhaps the Russell 3000 is better described as the Russell 2990 + 10? I don't have a practical solution, other than to consider tilting to small cap, but that doesn't mean that it isn't a problem.
One solution out of this conundrum is to realize that not individual stocks are alike when it comes to diversification.

Take a conglomerate like Procter & Gamble -- it has a zillion product lines and it's not hugely exposed to any. Should it count the same as a small player like Body Shop (assuming it was still independent)? Or Exxon with hundreds of oil fields everywhere the same as a small Canadian company that would instantly go belly up if something nefarious was discovered about shale oil? Perhaps Apple is the most problematic to this rationale, with its large concentration in one product (presumably something the market is worried about), but even Apple has exposure to many markets which are known to move independently wrt "mobile fashion", so you can make the case that it's more diversified than a Chinese player + an American player independently, and when owning it as a combination you're saving on duplicate R&D costs.

There has been a premium in small stocks, but it's partly risk (meaning not very valuable), partly liquidity + costs (which are going away), and partly the market being blind to a "factor" that it's IMHO in the process of assimilating. There are no easy ways to stock pick, like I was saying.

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Re: Why is Apple so heavy in VTSAX?

Post by Boglegrappler » Wed Oct 28, 2015 3:21 pm

Lots of conceptual "noise" here.

The idea of owning the index is to simulate what you would have if you owned every share of every company in the index. By definition, that is market weighted.

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Re: Why is Apple so heavy in VTSAX?

Post by LadyGeek » Wed Oct 28, 2015 4:19 pm

22twain wrote:
David Jay wrote:
nisiprius wrote:Or like the joke-scare publications warning that your drinking water contains dihydrogen monoxide.
Oh, noes !
http://www.dhmo.org/facts.html
:D
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Re: Why is Apple so heavy in VTSAX?

Post by alex_686 » Wed Oct 28, 2015 5:01 pm

Valuethinker wrote:For a company growing its earnings as fast as it does, Apple has a *low* PE. The PE of 14x (prospective) recognizes the fact that Apple's earnings per share (the denominator) are growing very fast, thus justifying a high share price (the numerator). That's actually below the US stock market as a whole? (about 20.0x prospective?)
Yes, companies with high growth expectations have high P/E ratios. Another way for a company to have a high P/E ratio is to use leverage - add liabilities to the balance sheet. Apple has few liabilities and lots of cash - so it has negative leverage, which is pushing it P/E ratio lower.

To keep this on point, this is one of the reasons why I favor free float market cap for indexes. It is theoretically pure and thus has few "gotchas" it terms of implication. Smart Beta, Equal Weighting, etc. add complexity which I am not sure is worth the benefit.

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Re: Why is Apple so heavy in VTSAX?

Post by inbox788 » Wed Oct 28, 2015 6:05 pm

razeus wrote:I'm curious why my admiral shares of VTSAX has such a heavy weighting in Apple. I know it's an index fund, but should the companies be equal? Apple is like 3-4x the shares of everything else.
It's not!

https://personal.vanguard.com/us/FundsQ ... thEnd=true

It's about 2x Google, Microsoft, or Exxon and 2-3x J&J, GE, Berkshire Hathaway, Wells Fargo, JP Morgan Chase, or ATT.

Should Amazon, Starbucks, McDonalds, Chipotle, and Panera all have equal weighting? If not, how would you decide the weighing?

Market cap is the worst method, except for all the others.

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Re: Why is Apple so heavy in VTSAX?

Post by nisiprius » Wed Oct 28, 2015 8:30 pm

Equal weighting is grotesquely illogical. I don't see how it is that people don't see it.

Let's say it is 1982 and AT&T splits up. Bing! One stock ticker symbol becomes seven. If you are cap-weighting, almost nothing happens. The shares of AT&T are automatically exchanged, cap-weighted, for about the same dollar value of shares in seven different companies. You have about the same amount invested in the seven baby Bells as you previously did in AT&T. (Believe it or not I actually owned AT&T and that's what actually happened).

But if you are equal weighting, when AT&T splits you now have seven companies and you need to go out and buy seven times the dollar value in baby Bells as you formerly held in AT&T. (Talk about potential problems with front-running the index!)
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Re: Why is Apple so heavy in VTSAX?

Post by ogd » Wed Oct 28, 2015 8:42 pm

nisiprius wrote: But if you are equal weighting, when AT&T splits you now have seven companies and you need to go out and buy seven times the dollar value in baby Bells as you formerly held in AT&T. (Talk about potential problems with front-running the index!)
Yes, it's unsound in that way and others. It can be front-run and it can even be exploited by company executives when deciding to split or merge. There's no way that equal-weight could ever sustain the kind of size that market-cap indexing has now -- it can only be done if you never [predictably] fight against the market movements.

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Re: Why is Apple so heavy in VTSAX?

Post by boglerdude » Wed Oct 28, 2015 11:30 pm

Are stocks with PEs 3x or more the market average riskier (more risk more reward?)

Are there enough of them to have a significant impact on the total market index fund

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Re: Why is Apple so heavy in VTSAX?

Post by Valuethinker » Thu Oct 29, 2015 4:04 am

nisiprius wrote:Equal weighting is grotesquely illogical. I don't see how it is that people don't see it.

Let's say it is 1982 and AT&T splits up. Bing! One stock ticker symbol becomes seven. If you are cap-weighting, almost nothing happens. The shares of AT&T are automatically exchanged, cap-weighted, for about the same dollar value of shares in seven different companies. You have about the same amount invested in the seven baby Bells as you previously did in AT&T. (Believe it or not I actually owned AT&T and that's what actually happened).

But if you are equal weighting, when AT&T splits you now have seven companies and you need to go out and buy seven times the dollar value in baby Bells as you formerly held in AT&T. (Talk about potential problems with front-running the index!)
One of the reasons why the Dow Jones Industrial Average is an oddity. 30 stocks, price weighted.

So if a company goes to zero the index would go to zero.

They manage it by being ruthless about inclusion/ exclusion. And we all use it as a reference point (a bit like Fahrenheit temperatures) because it has been around so long, and we all know roughly what it means. (in the long run, I think total return for DJIA and S&P500 have been close, so the fact that you'd never want to track something like the Dow has not really mattered).

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