Sure, you can find plenty of legitimate criticisms of the S&P 500 index. But don’t kick it out of your portfolio solely because you think it’s unstable. That very quality actually makes it more attractive.
The S&P is one of the best-known market gauges, but it certainly has its flaws. It’s market-cap weighted, meaning that the components with the largest market capitalizations account for most of its value. Thus, though there are 500 companies in the index, ExxonMobil accounts for fully 3% of its value, and its top 10 holdings make up nearly 20% of its value. With the tiniest stocks in an index fund only getting 0.05% or less of the fund’s assets, you’re not really participating in their growth. And you don’t get any exposure to stocks outside the U.S. or to smaller domestic stocks.
Change is good
Despite all that, the S&P 500 is still a decent way to instantly own chunks of many companies, which tend to grow in value over time. Thus, don’t let yourself be swayed by arguments that the index is “unstable.” One article I read recently noted that in the 40 years or so following the inception of the index, fewer than 15% of its original 500 companies remained.
Well, yeah. Over time, companies merge and spin off, and some just go out of business. Studies have shown that plenty of stocks removed from the index go on to do quite well, while others prove well worth removing. No investor ever makes perfect decisions, and neither do the folks running the S&P 500. But I like that the index is designed to include the “leading companies in leading industries of the U.S. economy,” rather than the leading companies of 50 or 100 years ago.
Last year, for instance, credit-card giant Visa joined the index, and the year before, MasterCard, following each of the companies’ entrance to the stock market via initial public offerings. It’s hard to imagine an index representing the U.S. economy that didn’t include these titans, each of which sports a market capitalization topping $30 billion.
General Motors has recently emerged from bankruptcy protection and is working on turning its fortunes around. It’s already a $50 billion company, so it’s hard to imagine the S&P 500 not welcoming GM back to the fold once the company meets its inclusion guidelines.
No less an authority than Warren Buffett has suggested that most of us would do well to just stick with a simple broad-market index fund. Warts and all, the S&P 500 index deserves serious consideration for a berth in your portfolio. After all, it’s averaged solid growth over many decades (including this last particularly tough one). And over long periods, stocks have almost always trounced bonds and most other alternatives.
Just be sure you understand what the index is and isn’t before you buy into it. It’s a market-cap-weighted, periodically tweaked index of large U.S. based companies, and a handy way to instantly get invested in most of the U.S. market.
An “unstable” index might indeed be a dangerous investment. But a dynamic index will help your money keep growing for decades to come.
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Longtime Fool contributor Selena Maranjian owns shares of General Electric. The Fool owns shares of Exxon Mobil. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.