The S&P 500 Is Hiding a Very Different Stock Market

[00:00:00] Speaker 1: The S&P 500 is sitting right at all-time highs, so the market's doing great, right? Not even close. Look inside, and more than half its stocks are below their long-term average. Just 10 companies now make up $38 of every $100 in your S&P 500 fund, and if they fall, your 500 company fund goes down with them. So the real question is, how exposed are you? Today, I'm gonna show you the very different stock market hiding under the S&P 500, why your portfolio might be lagging for a good reason, and a 30-second check to see how much of your money is riding on those 10 companies. Plus, I'll show you exactly how I set up my own portfolio. My name's Nolan Govea, my students call me Professor G, and I made this channel to make investing simplified. Remember that all investing carries risk, so do your own research. This is not financial advice, and I'm not a financial advisor. So let me start with something that we pretty much just do automatically. Someone says, how's the stock market doing? And so we look at the S&P 500. If the S&P 500's up, market's doing good. If the S&P 500's down, we say the market's doing bad. It's a useful benchmark, but there's definitely a catch. The S&P 500 weights large US companies by their market cap. So the biggest ones actually move the index the most. This is actually quite different than just how the average company in our society is actually doing. Here's the simplest way to understand that. Imagine I have 10 companies in a classroom example. They all start at the same size, so each represents 10% of the group. Now imagine one becomes 10 times as valuable while the other nine do not change. The one winner is suddenly worth a little over half of the combined group. Under market cap weighting, it gets a little over half the influence over the result. Notice that the other nine companies do not suddenly become worse businesses. We simply change the size of the biggest voice in the room. In an equal weight version of that same 10 company group, each company gets 10% when the weights are reset. Same names, but very different way of measuring their collective performance. This is not just a classroom trick. According to S&P Dow Jones indices, as of August 31st, the 10 largest companies made up 37.8% of the standard S&P 500. The single largest holding a loan was 8.1%. If you had $100,000 in a fund that tracked the index with those weights, roughly $37,800 of that was sitting in just 10 companies. Now, is that wrong? No, the standard S&P was built to reflect that size of those companies within its index. Bigger companies are supposed to carry more weight. And a cap-weighted fund naturally lets a more successful company become a bigger part of the portfolio without forcing you to sell it just because it's being successful and just because it grows. But now suppose you wanna answer another question. Are the actual gains spread across all of that diversification within the fund? Or is it really just concentrated in just those couple of top names? That's where the S&P 500 equal weight index comes in. It holds the same companies, but assigns them approximately 0.2% each at its quarterly rebalance. It gives the smaller names in that universe a much louder voice. And that's what those numbers at the start were telling us. MarketWatch reported on September 23rd that the S&P 500 is only 0.44% shy of its record, even though 52% of its stocks were below their 200-day moving averages. Fewer stocks are carrying the market than at any time since the dot-com peak. A long-term moving average is not a verdict on a business, but it does show how uneven participation can be underneath a healthy-looking headline. That's the very different stock market hiding inside the S&P 500. The regular S&P 500 and the equal-weighted S&P 500 are looking at the same basket, but with a different lens. The standard version tells you what the largest companies are doing to the benchmark. The equal-weight version tells you more about how the typical stock is doing. You want both views because neither one's telling you exactly what's actually going on in the whole market. And once you see the difference, it can explain something that might be very frustrating in your own portfolio. So for example, let's say that the S&P 500 is having a fantastic stretch. You own a sensible mix of assets, including investments outside US large-cap stocks, and your account's not keeping up. It's easy to feel like diversification at that point has stopped working. Maybe you need to buy the giant winners. Maybe you picked the wrong ETFs. Maybe everyone else knows something you don't. But think about what you're comparing. A cap-weighted S&P 500 fund is a US large company portfolio with meaningful exposure to its biggest stocks. A portfolio that also owns international equities, smaller companies, or bonds was deliberately built to do a different job. It was never guaranteed to match that one index month after month. And this is why when I'm meeting with clients, I always tell them, let's not judge the portfolio after one month, three months, even six months. I usually like to look at year's worth, and that's how I usually pick new ETFs for the portfolio. I wanna see long-term data. And for this video, I'm not assuming that everyone just owns only an S&P 500 fund. You probably are doing something similar to me with the three fund portfolio, or something of that nature. But looking at the regular S&P 500 versus the equal-weight S&P 500, S&P Dow Jones Indices reports that the equal-weight version beat the standard index by roughly seven percentage points in 2022, when many mega-cap growth leaders had a difficult year. The important detail is that this was relative outperformance. It doesn't mean that equal-weight investors avoided a bear market altogether. And that difference cuts both ways. During a stretch when the largest companies lead, the cap-weighted benchmark can pull away from a more balanced portfolio. When leadership rotates, the very same diversifiers that look disappointing may start contributing more. And now what I see is people say, well, this index is doing better, or this one's doing better, and so I'm gonna switch to that. What you're actually doing is selling low and buying high, and that never works out. You also need to know that equal-weighting, this equal-weight S&P 500, is not just the standard S&P 500 with a couple of the bigger stocks just dialed down. S&P explains that it naturally shifts more weight toward the smaller members of the large-cap universe, tends to lean more toward value, and rebalances away from recent winners. Those are real trade-offs, so equal weight won't automatically do better. So remember to ask yourself, what did you build this portfolio to do? What's the overall goal? If you bought a US large-cap index fund, then the S&P 500 is a sensible benchmark. If you built a mix of US stocks, international stocks, and bonds, evaluate those parts against their own roles, and then assess your overall plan. There's no point buying several diversifiers and getting angry whenever one of them behaves differently. You're always gonna have something that might be lagging other parts of the portfolio. That doesn't necessarily mean it's time to kick that out, and actually that could lead to a huge, huge mistake. So let's put two options side-by-side. In the standard S&P 500, a company that becomes more valuable generally gets a larger index weight. That can concentrate your holdings when a small number of giants race ahead, but it also means the index is not constantly trimming every winner simply because it has grown. In the equal weight version, those big positions are reset to roughly the same weight as the smaller names every quarter. This spreads single company exposure more evenly, but it also creates more turnover and a natural bias towards selling relative winners and adding to relative laggards. So you spread out your risk, but you keep selling the stocks that are working. This is why I'd never tell you that a narrow market means that a crash is coming. So right now in the headlines, with this whole idea of the S&P 500 being concentrated in just those couple of stocks that I talked about from the beginning, doesn't necessarily mean the end of the world. It is still very important for you to understand what you're actually invested in within your portfolio though. If you think you're in a very diversified mix, but you're really concentrated only in a couple names, and then you go to add even more of that into your portfolio by adding some individual stocks, that could really hurt your risk. And you don't need to solve this by changing one weighting formula and declaring it the winner. You need to know and understand what you actually own. And my favorite tool for this is something called Simplify. My team and I developed this site and app to be able to find fund overlap and actually see what you actually own within your portfolio and to see what types of stocks are overlapping between a portfolio that has a couple of different types of ETFs. So when I compare QQQM, VGT, and VUG, you can see that there's heavy overlap, but even better is this visually down here so you can actually see what's in each of these ETFs and how the overlap actually comes through. And this is my favorite part, the constellation view, to where you can see that if I click on Microsoft, it's in all three of these. NVIDIA's in all three of these. Apple. Google's only in two, but Broadcom's in all three. When you click on the Redundancy tab, you can see it here in plain English that all three of these have a heavy overlap. So if I go back and I add another ETF, something like SCHD into the mix, and then we go down to that same tab under Redundancy, you can see that SCHD actually has very little overlap and it's actually complementary towards each one of these. And if we go back to that constellation, you can see it easily here that the companies SCHD may be heavier in are not the same as the rest of them. So it may be a good add to the portfolio depending on your overall goals. So when people ask me, should I add this ETF to the portfolio or this stock? I just say, what do you have in your actual portfolio? Using that tool, Simplify, really helps you to understand exactly how much of everything you have and it's visually right there. It shows it bigger if you have too much of it and maybe you wanna shy away from it. The link to go check out Simplify is down in my description and it's pinned in that first comment. So try that out today. Here's a simple 30-second ETF check. First, open your largest equity ETF and look at its top 10 holdings. Most fund pages show what percent those top 10 make up. Multiply that by how much of your portfolio the fund is. If an S&P 500 fund is half your portfolio, about 19% of everything you own sits in just 10 companies. Second, ask whether your other ETFs own many of the same names again. Three ETF tickers are not necessarily three different exposures. And third, identify which of your funds actually give you international stocks, bonds, or other areas outside the US large cap group. Finally, ask whether those differences are intentional and still fit your goal. The goal is to finish that check with a plain English answer. Not just I own VU and two or three other ETFs. What I want you to be able to say is, here's how much of my portfolio depends on US mega caps. And here's how much of my portfolio is in value versus growth. Or here's how much of my portfolio is in international. And exactly why you chose it that way. Clear for you to be able to see and understand. In all my experience with all my clients, the ones who do the best are the ones who understand their entire portfolio and have a very clear picture, which is why I really like that simplified tool. And it's why we built that out. So definitely check that out in the description down below. But if at the end of the day, you realize you want to have less of mega cap concentration, there's several possible ways for you to actually address it. Equal weight exposure is one possibility. Broader US funds, different stock styles, international diversification, and the right fixed income allocation may also play roles depending on the problem you're trying to solve. None's an automatic upgrade for everyone. Just make sure you're making the decision based off of your long-term plan, not off of some headlines or emotions or what's happening just in the last month or two. So is the S&P 500 hiding a very different stock market? Yes. The index can sit near a record while more than half of its stocks struggle. It's doing exactly what it was built to do, measuring large US companies by their market value. But at least now you know how to see what's underneath and you can make a decision based off of that. I personally am not moving away from the regular market cap weighted index. It's done its job since pretty much forever. And I truly believe in that. It's one of my main cores within my portfolio. If you want to see how I put those principles into action, watch this video here on my three fund portfolio, not just what those funds are, but the actual percentage one may want to have based off of age, because you definitely want to change as you get closer to retirement. Or watch this one to keep you going strong and investing and keep investing simplified.