It’s happening again.
If you’ve been investing long enough, you’ll remember that stock index funds loaded up with tech stocks just before the 1999 tech wreck, and piled on an extra helping of bank and financial stocks in advance of the 2008 financial meltdown.
Market-weighted index funds are popular with investors, but they have an unfortunate downside: the more expensive certain stocks get, the more the index buys.
That’s the opposite of what savvy investors are supposed to do.
Are they getting themselves into trouble once again?
Tech stocks have been on a tear in 2017. That’s pushed the weighting of tech stocks in popular S&P 500 index funds from around 20% of the total to almost 24%, a significant increase. That’s not totally surprising. Technology is becoming more pervasive in all aspects of our lives – and the economy – so it’s normal to expect its share of the economy to grow.
But it’s also true that some investors might be getting more than they bargained for.
“It’s sort of an inherent flaw of index funds,” said Minnesota advisor Kyle Moore, interviewed by the Journal. A typical investor might want to trim exposure to those stocks and take profits, said Mr. Moore. But when you invest in an index fund, that doesn’t happen. In fact, as long as prices continue to rise, the fund will keep adding more and more tech.
The accompanying graph, prepared by Bespoke Investment Group, shows the growing weighting of tech in the S&P 500 index. Tech is not yet near the combustible 30%+ level it reached before the tech meltdown (see the spike in the graph), but it has climbed noticeably in recent years (the current weight has recently climbed to just under 24%).
What’s the solution?
If you’re an aggressive investor happy to go along for the tech ride, there may be no need for remedial action.
But more mainstream investors might want to make some adjustments. Too much of anything can be a problem, and tech has been notoriously volatile.
You may be more comfortable moving from a passive index that mirrors market weightings to an equally-weighted index, actively managed fund, or a “Smart Beta” hybrid. An equally-weighted S&P 500 ETF has less than 12% of holdings in tech, compared to nearly 24% in the market-cap weighted version. That would have cost it in 2017 market performance, but might pay off in spades if tech stumbles.