S&P 500 Index Fund: Is it All That It's Cracked Up to Be?

I’ve been huffing and puffing about the S&P 500 Index fund's great qualities for many years now. But in the back of my mind, I’ve always fretted about how much of the fund’s success in recent years has been tied to those huge (and often overhyped) technology stocks - and two or three other big dogs. Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

S&P 500 Index 101

According to Investopedia, the S&P 500 Index fund - or Standard & Poor's 500 Index - is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S.

"It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes. Still, the S&P 500 index is regarded as one of the best gauges of prominent American equities' performance, and by extension, that of the stock market overall." --- Investopedia

Because it's a free float-adjusted market-cap weighted index, the index is continuously recalculated based on the number of member shares available for trading. The larger a company is, the greater weight its stock will represent in the S&P. In short, the index is weighted toward large-cap companies…and some of them are true behemoths.

Bull-Headed Index

Without question, the most recent Bull Market was propelled significantly upward by the S&P 500’s 10 biggest stocks, which made up 30% or so of its market cap. By definition, these big dogs had an outsized impact on the index’s recent performance. In fact, it’s not uncommon for three-quarters of the index's return to be linked to only 50 to 75 stocks; thus, my continuing anxiety about that outsized impact. Why? Because, by definition, those same companies are having a similarly negative impact on the index’s performance in the current Bear Market.

In short, because those 10 biggest stocks were driving up the market’s valuation, it’s logical to assume that any major market decline would mean hard times for that same market if and when the value of the big dogs come tumbling down. And, as if we needed to be reminded, the current market is putting this theory to the test.

Top Ten Decline

The top 10 S&P 500 stocks (as of September 2021) and their current “peak-to-trough” declines from their high include:

(1) Apple -15.3%

(2) Microsoft -24.1%

(3) Google -28.1%

(4) Amazon -34.4%

(5) Facebook -55.7%

(6) Tesla -33.6%

(7) Berkshire -20.6%

(8) Nvidia -48.1%

(9) Visa -14.8%

(10) JP Morgan -33.2%

The average drawdown of the top 10 stocks from last fall is a decline of about 30% compared to a decline in the total S&P 500 of roughly 17.5%. Surprised? I was. Without digging, I would have assumed the stock market would be down much more than 17% had I been told its top 10 stocks from last year were down 30%...almost twice as much.

Only two of the top ten stocks - Apple (-15.3% and Visa -14.8%) - “outperformed” the S&P 500. The remaining eight were down more than the S&P 500 - some of them significantly more. Yup, the S&P 500 outperformed the majority of those big fellas by a significant margin. How is that possible? Goes to show you that it’s not just the big shining stars that matter when it comes to performance.

Tough Tech Times

Without question, the tech sector is going through a rough patch this year, but thankfully, they do not make up the entire stock market. Often, it’s the more unexciting sectors that save the day in hard times - like energy (+31%!), utilities (-1.5%), consumer staples (-3.9%), healthcare (-7.2%), etc. Still, it’s hard to believe that the broad market is not down more than it is in light of the Big Ten's performances.

Overcoming Obstacles

Since Covid’s onset, the S&P 500 is up almost 28%, dividends included. That’s an annualized return of 10% for U.S. stocks...in step with the market’s long-term average annualized return. That's just another reason for investing in the S&P 500 or Total Stock Market Index funds as the core of your portfolio.

And think of the hills the market has had to climb since January 2020. Wind, sleet, snow, the pandemic, volatile oil prices, inflation, rising interest rates, political buffoonery, etc. all came into play. Not to mention a 34% drawdown from February to March 2020, the fastest Bear Market in excess of 30% in history from an all-time high…and a startling subsequent gain of 120% from those March 2020 lows through the first trading day of this year. And now, of course, a market decline this year of nearly 24% at its worst point. Whew! two Bear Markets and a massive Bull Market in less than 36 months! How’s that to get the adrenalin pumping?

Not a bad yield despite those many obstacles. And it ain’t over until it’s over.

In Sum

At this point, whether the Bear continues to growl or goes into hibernation, if you can avoid paying attention to your shrunken investment portfolio, that’s probably a good thing. During these difficult times, investors should patiently contend with their losses.

As long as you have a high-quality, highly-diversified investment plan, long-term returns are really the only ones that matter. And yes, it sometimes means living through Bear Markets with poor returns. Losses are simply a part of successful long-term investing. There’s not much you can do to avoid them if you wish to earn a decent return over time. And what’s wrong with 10% or so on average? Be patient. This, too, shall pass.