Many people assume that the S&P 500 is the actual US market. It is not. It just happens to be one of the most oft quoted proxies for the market. In fact it is quite a lop-sided proxy for it.
Here are some interesting facts sourced from Research Affiliates and Rob Arnott:
- From March 2000 to March 2002 the S&P 500 lost more than 20%, meanwhile the average U.S. listed stock gained more than 20% – this seemingly anomalous result is due to the market-cap weighted nature of the S&P 500 where more value is place on larger stocks
- If you look at only the top 10 stocks in the S&P 500 from 1926 to 2006 (a full 81 years of data), they outperformed the average US stock only 31% of the time over any 10 year rolling period
- What’s worse, is that if you try to find the number of years where 6 or more of the top 10 stocks by market cap in the S&P 500 beat the average stock: It never happened during the entire 81 years
So based on this, one could argue that if you bought a index tracking investment, one that tracked the S&P 490 (a fictitious index comprised of the S&P 500 less the top 10 stocks by market cap) instead of the S&P 500 might be better. The reason for this underperformance is attributed to the fact that the top 10 stocks tend to get that way because they are overvalued, and they also happen to represent about 25% or more of the S&P500 – again based on the market-capitalization nature of the index constitution.