Introduction
Per my July article, there are many advantages to investing in the S&P 500 (NYSEARCA:VOO). One of the key advantages is maintaining a relevant portfolio as the world changes. My thesis is that the S&P 500 keeps investors from missing out on transformations.
A Changing World
I was recently listening to an investor call from a well-respected active fund. Management answered a question as to why the fund does not have any holdings in the Magnificent 7 which are Tesla (TSLA), Amazon (AMZN), Meta (META), Apple (AAPL), Microsoft (MSFT), Alphabet (GOOG) (GOOGL) and NVIDIA (NVDA). These are companies that are embracing a transformational time in the world as we figure out how to utilize AI. Passive S&P 500 investors have plenty of exposure to these companies as they pivot but active investors sometimes miss out.
A December 2023 FT article by John Gapper talks about the way Nvidia rose in value as it pivoted from video games to machine learning (emphasis added)
It changed direction a decade ago, but gaming remained its biggest revenue source until last year. Nvidia’s transformation is one of the sharpest of all business pivots, matching Nintendo’s historic move from playing cards to consoles, and Toyota’s from weaving looms to cars.
Few people saw Nvidia’s pivot coming but passive long-term investors in the S&P 500 benefited from the change. It isn’t just Nvidia, many companies are transforming with AI, and S&P 500 investors are participating. A May 2023 S&P Global article sums up the importance of the big tech companies that are embracing AI by saying the Magnificent 7 were responsible for more than 110% of the S&P 500’s 2023 gains through mid-May:
Big Tech is largely fueling the S&P 500’s positive performance in 2023, with investors buying just seven stocks and selling pretty much everything else. Those seven stocks – Apple Inc., Alphabet Inc., Meta Platforms Inc. Microsoft Corp., NVIDIA Corp., Amazon.com Inc. and Tesla Inc. – have seen significant gains after a bleak 2022, and the collective gains have kept the S&P 500 in positive territory in 2023, with the overall index rising about 7% since the start of the year. Without these seven stocks, which make up nearly 26% of the large-cap index’s total weight, the S&P 500 would be down 0.8% on the year, through May 16.
Again, by owning VOO, investors own each of the companies in the Magnificent 7. At the time of this writing, these companies combine to make up more than 28% of the VOO weighting. Nvidia entered the S&P 500 back in 2001 but its weighting was much smaller until recently. Looking at the portfolio composition of the VOO fund, Nvidia and the other Magnificent 7 companies stand out:
Active fund managers are paid for performance; they are incentivized to invest in transformative companies. However, it can be difficult to find transformative companies and even when outstanding companies are found, the fees paid to managers are pernicious over long periods of time. The 2018 book, Stay the Course: The Story of Vanguard and the Index Revolution, tells of the way John Bogle helped retail investors by making index funds widely available. It says the passive S&P 500 outperformed 92% of all active large-cap funds on a 15-year basis through 2017. The outperformance has continued as we look at newer numbers. The Mid-Year 2023 S&P Indices versus Active (“SPIVA”) U.S. scorecard says the S&P 500 outperformed 93.58% of active large-cap funds over the last 20 years. Outperformance has tended to increase over long periods of time although the 10-year period was an exception:
The above percentages are staggering; it isn’t easy to find the next Tesla or the next Nvidia – not even for professional managers. Berkshire Hathaway (BRK.A) (BRK.B) CEO Warren Buffett made a 10-year bet to show that the passive S&P 500 fund would beat fee-based funds with active managers. Berkshire’s 2017 letter to shareholders shows that CEO Buffett won the bet with the passive S&P Index Fund:
Closing Thoughts
Regarding John Bogle’s Stay the Course book mentioned earlier, this part of advice is important (emphasis added):
Here’s my simple recommendation for ETF investors and TIF investors alike: emphasize broad-market (e.g., S&P 500) index funds in your portfolios, and don’t trade them.
[ Stay the Course kindle book: Location: 3,053]
I agree with this mindset. Rather than trying to time the market with VOO trades, I tend to see it as a buy if the investment can be left alone for at least 3 years.
Disclaimer: Any material in this article should not be relied on as a formal investment recommendation. Never buy a stock without doing your own thorough research.
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