Would you like to have your investment portfolio or your workplace 401(k) managed by the top 15 percent of all money managers in the world?
It’s a serious question. Think about having a professional who is considered to be in the top 15 out of 100 money managers in the world managing your money.
When I ask this question most investors say, “Sure, that would be great! How can I do this?”
The answer is very simple: Just invest in the Standard and Poor’s 500 Index (S&P 500). In the past 14 years, the S&P 500 beats 85 percent of all money managers out there.
But let’s be real, is that really what you want?
Let’s say you invest in the S&P 500 and it is down 10 percent in a year, but your manager loses only 9 percent. They outperformed the S&P 500. You lost 9 percent. The money manager gets an extravagant vacation, a huge bonus and most likely a promotion.
The next year the S&P 500 is down 10 percent again and your manager is down 9 percent. So, on paper, they’ve outperformed for the second straight year. They are in the top 15 percent of all money managers in the world. Another vacation, a meatier bonus and even bigger promotion.
But you lost another 9 percent in the past year, and 18 percent of your investment over two years. So, while your money manager is rested, tan and rich, you’re down 18 percent.
Now, I’ll pose the question again: Would you like to have your portfolio managed by the top 15 percent of all money managers in the world?
Let’s put this same analogy to the test in terms of the market indices. The traditional S&P’s 500 Index is a “cap-weighted” index. What this means is that the larger companies, the ones with the biggest market capitalization, carry the most weight or the biggest impact.
So, let’s say ‘Company A’ has 100 million shares outstanding and the share price is $5 per share. Then the market cap is 100 million shares multiplied by $5, or $500 million.
‘Company B’ also has 100 million shares outstanding, but the share price is $10 per share. So, 100 million multiplied by $10 is $1 billion in market cap. On a cap-weighted basis, ‘Company B’ at a $1 billion is twice the size of ‘Company A.’
So, the big dogs, or the big companies at the top of the list, control how the index does as a whole. Right now, the biggest company in the S&P 500 is Apple, followed by Microsoft and Amazon. A lot of the performance of the S&P 500 is tied to what these three particular companies do.
The top 50 stocks in the S&P 500 represent nearly half of the index. So, 50 of the 500 stocks represent 50 percent of the index. The other 450 names represent the other half.
Here’s a tip: You can outperform the S&P 500 with the S&P 500.
Yep, you can outperform the S&P 500 with the S&P 500. See, there are actually two S&P 500’s. There’s the cap-weighted S&P 500 index, which is the one most folks normally invest in when they’re putting their money into the S&P 500. But you can also invest in the S&P 500 on an “equal-weighted” basis.
The equal-weighted S&P 500 owns the exact same 500 stocks as the cap-weighted index, but each stock has an equal weight. What this means is that each stock gets only one vote. Apple, the No. 1 stock on the index, is equal to News Corp. Class B, the No. 500 stock in the index.
This is important to know because since 2003 (when the S&P 500 equal-weighted index was created) the index has outperformed the traditional S&P 500 in 10 out of 14 years. It has also outperformed more than 96 percent of all money managers in the world, according to The Index Group, Inc.
Your homework for this month is to ask your advisor a simple question: Did you know there are two S&P 500s? If the answer is yes, you have a keeper. If they look at you like you have a lampshade on your head, it’s time to start shopping for a new financial advisor.