Keep an Eye on Your Index Fund Dollars. You May be Surprised.

There has been a lot of talk about index funds in the last six months.

Warren Buffett recently said he recommends you, and his wife, don’t pick your own stocks, but simply “buy an S&P 500 low-cost index fund”. 

I recently heard on the news that at least 60% of the money in the market is in index funds.

Some Wall Street types are referring to Index fund investors as “dumb money” and worrying that no one is looking a company stats any more.

I am not going to talk about these things. They are for more nuanced investors. I am just a fairly smart guy who is a bit risk averse and likes things that make some sense.

We know we should not pick our own stocks unless we really understand the business sector that a company is in and the performance metrics of the business. Very savvy investors even look at management teams and may even compare them to the management teams of rival companies. Most of us to not have time to do that for more than a company or two.  We can’t even look at one whole market sector, let alone the whole market. It really does make sense from this perspective to look at index funds, but wait…

We are also told to diversify our portfolios.  All the more reason to use an index fund. Only…

We are also told to not put all our eggs in one basket. We should have a good speared of U.S. and foreign stocks, we should have a lot of different business sectors. There are international index funds, so we are covered there too.

BUT WAIT

You and I probably thought that if we bought an S&P 500 Index fund that we’d be getting a good mix of the S&P 500. WRONG!!  All your eggs are in one basket! If we look at just the top 25 holdings, 12.5% of your portfolio in in Tech stocks! That’s right, the index is weighted, usually by market cap or some sort of adjusted market cap. If you go down the list, the top is dominated by Tech, finance, pharmaceuticals, and finance

Breaking down your ownership by sector in the top 50 of the S&P 500.

Sector	%
Aerospace	0.64
Consumer Goods	2.77
Finance	6.13
Insurance	0.87
Oil	3.02
Pharma	4.28
Retail	0.56
Soda	1.61
Technology	16.4
Telecom	2.96
Tobacco	1.44
(blank)	6.8
Total	47.48

 

That’s right, just under 50% of your investment in 500 companies is in only 50 companies, and a very unbalanced 16% is in the tech sector. If we look at the bottom 50 companies, you only have 1.4% in them.

As always, these are just things to consider.  I have no useful money advice.