This week, I’m talking about how to avoid the hidden danger of index funds. 

Today, I’m continuing yesterday’s discussion about how when you look under the hood of virtually every S&P 500 index fund, the diversification you find is lacking and troublesome. 

Did you know that the 5 biggest companies in the S&P 500 make up over 15% of the index. 5 companies out of 500 - just 1% of the total number of companies make up 15% of the weight and performance results of the index. These are Apple, Microsoft, Google, Amazon, and Facebook. 

And what else do you notice about all of these companies? They are all big tech firms. Compare these big tech stocks to Costco or Nike which each make up only about ½ of 1% of the index, and you begin to see that the S&P 500 index fund that you’re invested in isn’t as diversified as you think. In fact, if you bought just 20 individual stocks across a variety of industries in equal weights, you would be more diversified than the S&P 500 index. 

My point here is that you need to know what you really own when you buy index funds. What’s under the hood and what are your largest holdings? I use the example of the S&P 500 index fund, but most index funds and ETFs are market-weight which means the largest and often most bloated or overvalued companies could carry the most weight, and be the most influential, which helps when they’re moving up, but when you look back historically, it also leads to bigger drops on the downside as well. 

The takeaway here is that while you can build a diversified portfolio with index funds, you can almost never build a truly diversified portfolio with just one or two index funds. You may think you’re diversified, but chances are, you’re not. 

That’s it for today. Thanks for listening. My name is Ashley Micciche and this is the One Minute Retirement Tip. 

----------

>>> Subscribe on iTunes: https://apple.co/2DI2LSP

>>> Subscribe on Amazon Alexa: https://amzn.to/2xRKrCs

>>> Check out our blog: https://truenorthretirementadvisors.com/blog/

----------

Tags: retirement, investing, money, finance, finances, financial planning, retirement planning, saving money, personal finance, wealth management, money tips, fee only financial advisor, financial planner, financial podcast, retirement podcast, financial independence podcast, index investing, ETF investing, index funds, ETFs, etfs vs mutual funds, etf vs stock, how to invest in index funds