As the owner of a Ford F-150, I don’t compare my ride’s zero-to-60 performance to a Ferrari or my gas mileage to a Toyota Prius. Each vehicle was designed with a different objective in mind and comes with its own set of expectations. Yet many investors commit this kind of mistake when benchmarking their portfolios, and that can present a challenge for advisors.
Last month’s volatility notwithstanding, U.S. stocks have been one of the few shining beacons of positive returns in the global financial markets this year. Most asset classes are in the red, and even in the U.S. the gains are not as widely distributed as they appear. Through the end of October, the 10 largest companies in the S&P 500 accounted for 85% of the index’s year-to-date return, and the largest decile represented 110%, meaning the other 450 companies were down on average.
It’s understandable that the S&P would attract the majority of the financial media’s attention and coverage. It counts among its constituents some of the largest and most competitively dominant corporations in the world, and the index represents just over 80% of the total U.S. public equity market capitalization. But the disproportionate amount of airtime given to covering the biggest 100 or so mega-cap names creates skewed perceptions by individual investors about the state of financial markets and the type of returns “everyone else” is getting.
By the time your client calls you, their advisor, to ask, “Why is my portfolio down when the market is up 5%?” there’s a good chance they’ve accumulated a whole set of unrealistic expectations that are framing the question. This can either be an awkward moment or an opportunity for you to demonstrate your value by educating your clients on the difference between “the market,” a particular index, and a diversified portfolio.
Indexes Outnumber Stocks
These days, you can find an index tracking almost anything — emerging markets, tech companies, volatility, growth stocks, value stocks, smart beta, international markets, commodities, industries, and ESG factors, just to name a few. Yet if you talk to most investors, the only benchmark they know is the S&P 500, or for the truly old school, the Dow Jones industrial average.
There are now more indexes tracking stock market performance than there are individual stocks. Advances in technology, the rise of factor investing, and the proliferation of ETFs have driven the number of indexes up at a parabolic rate. Bloomberg reported last year that the number of market indexes quadrupled to 1,000 between 2010 and 2012 and had already crossed 5,000 by the end of 2016, while the number of publicly traded U.S. stocks has fallen to fewer than 4,000.