The S&P 500 index has reached a record closing high amidst ongoing concerns of a federal government shutdown, reflecting a nearly 90% increase since the onset of the current equity bull market three years ago. This surge has been significantly influenced by advancements in artificial intelligence, as highlighted in recent research from Morgan Stanley Wealth Management.
However, financial experts suggest that investors may need to rethink their reliance on the conventional S&P 500-focused investment strategy. Michael DeMassa, a certified financial planner and founder of Forza Wealth Management, expressed concerns, stating that the index is “broken.” Despite common perceptions that investing in the S&P 500 via popular ETFs like SPY, VOO, or IVV offers diversification, DeMassa argues that this belief is misleading. The market capitalization-weighted structure of the index means that larger companies can disproportionately affect overall performance. Furthermore, the heavy weighting of technology firms might result in increased volatility that affects the entire index.
Deva Panambur, another financial expert and founder of Sarsi LLC, maintains that while the S&P 500 can yield positive long-term results, there are periods when it struggles significantly. He referenced the period from 2000 to 2008, during which the index fell more than 30%. Despite general positive forecasts from Wall Street for the index’s near future, experts advise investors to consider a more diversified investment strategy to cushion against potential downturns.
To achieve better diversification, Brendan McCann, a research analyst at Morningstar, recommends investing in total market index funds instead. These funds provide access not only to large-cap stocks but also to small- and mid-cap companies, creating a more balanced portfolio. For those with existing S&P 500 funds, McCann suggests enhancing diversity by incorporating additional funds that track broader indexes or exclude S&P 500 stocks, such as the Vanguard Extended Market ETF.
For investors averse to adjusting their asset allocations frequently, total market index funds can be a favorable option, especially for those invested through accounts like 401(k)s, where tax implications for changing funds are minimized.
Moreover, some experts advocate for equal-weighted S&P 500 index funds, which maintain an equal stake in each stock. The downside to this approach, however, is increased transaction costs associated with rebalancing the portfolio. Panambur observed that during past downturns—from 2002 to 2009—other sectors, including small caps, value stocks, and international markets, outperformed the S&P 500. In response, he has adjusted his clients’ portfolios to include these various asset classes.
As the investment landscape evolves, DeMassa warns that the traditional set-it-and-forget-it strategy linked to the S&P 500 may no longer suffice for achieving broad market exposure. Investors are encouraged to closely monitor their portfolios and the specific holdings within their funds to avoid unexpected concentrations in large-cap technology investments. As diversification becomes increasingly critical, a more proactive approach may be necessary to safeguard against future market fluctuations.
