If you had followed the advice of those experts with warnings such as “sell everything now as we will have a crash as bad as 2008” this was RBS, or perhaps as Goldman Sachs predicted in 2014 USD 200 for a barrel of oil, wrong, so in 2015 they predicted USD 20 wrong again.
To have followed the advice of these experts would have resulted in losing a lot of money.
However, you may be thinking that even your portfolio is not doing what the market is and wondering why?
As such I thought I would look at the stock indexes to help explain why your portfolio may not reflect the performance of the stock market indexes such as the Dow Jones or the S&P 500. Worse still, you may wonder why the market is going up but your account is going down.
Now we keep hearing on the TV and reading on the internet about the Dow Jones and the 20,000 level, the Nasdaq and S&P are steadily hitting new highs. Even the Russel 2000 gained 20% in one month.
However, this does not actually reflect what is going on in the market, as such it may not reflect what is going on in your portfolio.
The US has almost 5,300 listed companies in the NYSE and Nasdaq, yet the Dow Jones only has 30 companies and the S&P 500 only has erm.. 500.
If you have a mutual fund, it will most likely have a maximum of 50-60 stocks. As such it would be unlikely to mirror image the index unless it was a closet tracker. An ETF however is composed of all the same stocks and weighting as the index.
Let me explain how the index distorts the true state of the market.
The S&P has 500 companies, but the calculation is not 500 stocks equally weighted giving an index price of 2,300.
The top two companies from these 500 have a weighted value of 5.87% of the index and the top 10 have a weighted value of 17 pct.
Think about this, if the top 10 stocks went up by 25% and the remaining 490 stocks went down by 5%. The market would still be showing a gain of 0.1%
Ie these 10 stocks only represent 2% of the companies in the index but they have a huge effect on the index performance and the index performance does not really show the actual performance of the majority of the stocks. Confused? You should be. You could be in a bear market but still have a rising index.
This is not just confined to the S&P it is the same with the Russel 3000. This index gives a better representation of the US economy due to the number of stocks in the index. However again the top 1,000 stocks are the equivalent of 90% of the index and the remaining 2,000 only representing 10% of the index.
This is one of the reasons most mutual funds have a problem outperforming the index unless they take a few big bets on a few stocks or is a closet index fund.
If you want to mirror the index an ETF is ideal. It will not beat the index but it should track the index.
It is time to distance oneself from the way the main stream thinks about performance and benchmarking.
It is also not about making predictions, even a broken clock is right twice a day, the clock however is still broken and I would not use it for investing, i.e.. Market timing, guessing the market is a fool’s game.
Reduce risk and costs using ETF’s and don’t forget to diversify into other asset classes.
Have a great and prosperous 2017.
If you have any questions just mail me at firstname.lastname@example.org