May 03, 2022

View online | Sign up

TOGETHER WITH

Good Tuesday to you. Of the roughly 500 companies in the S&P 500 Index, the top 1% or top 5 companies in the index makeup what percent of the index's total weight? a. 1%, b. 10%, c. 20%. Follow the wave 🌊 below for the answer.

Here are the topics for today 👇

A blessing and a curse: Concentration risk
Index fund bubble? Arguments for and against it
Looking to move to another US state this year?

MANAGING YOUR WEALTH

A Blessing and A Curse: Concentration Risk

As stoic philosopher, Seneca once said, “excess in anything becomes a fault.”

Is that always true though? Not particularly. Sometimes honing in on a single focus can yield great results, that’s why the modern job market is so specialized. Other times though, being too narrow can leave you vulnerable, meaning you might need to find a middle ground.

Suffice it to say, concentration can be both the main creator and destroyer of wealth, so where’s the right balance?

Everyone is overly concentrated somewhere

Passive concentration: Most investors are passive investors, and for good reason too. Timing the market is next to impossible, an emotional rollercoaster, and often unsustainable, which has led us down a natural progression favoring passivity, and ultimately, index funds. It’s a great invention, but it may have its potential pitfalls in certain market cycles like we’re in now, such as the problem of being top-heavy. For example, the S&P 500’s top 10 holdings make up almost 30% of the index’s weight. The bottom 10 don’t even make up one-tenth of a percent. Mega caps move the markets. Love it or hate it, this method has outperformed equally weighted strategies too—just compare $SPY with $RSP.

Concentration via familiarity: Let’s say you’re an Apple fanatic and believe wholeheartedly in the company and its products. You can fix any iPhone issue, name their marketing director, and quote their intraday book value like your first-born child's birthday. You invest consistently in the stock over time, build a substantial position, and are up massively. But suddenly, in 2025, Apple has a mishap and drops 35% in a day. And you might have just lost five figures. It’s good to know what you’re investing in, but you can also easily hone in on one company you like to a fault, essentially putting the blinders on for risk.

Compensation concentration: If you’ve been or are being compensated by your employer with equity, you may have some concentration vulnerabilities too. If too much of your net worth is tied up in company stock and stock options, your net worth may be at risk. Case in point: Netflix’s stock recently plummeted by 35% in a day after the streaming media company reported losing 200,000 subscribers in the last quarter.

So what do you do about it?

Determine what you're okay with. Your risk tolerance is the most preliminary step here because it’s far from the deciding factor in deciding how diversified you should be. What are your short and long-term investing goals? How much risk are you willing to take for each of those goals?

Your risk tolerance and time horizon are key inputs here. Knowing where your redline sits is important and can help you determine to what degree to let your portfolio’s allocations deviate from the norm. If you’re 60 with a $1M nest egg with 50% of it in $QQQ, well... we miiiight have a problem, but if you’re 20? That’s dodgy, but maybe that's okay since your time horizon is more like 45 years (assuming you retire at 65 years old).

📈 Here's a related lesson on this topic:

Concentration Risk & Your Equity

9 mins

THE MARKETS & INVESTING

Index Fund Bubble? Arguments For and Against It.

Everything evolves and adapts over time—the stock market and how we invest are no exception to that rule. That very necessary change is a recurring point of debate, with almost every new caveat leading us to ask “is this sustainable?”

The latest in a long series of these is the index fund quandary. The kingpin niche of passive investing has become a massive whale over the last couple decades, and some analysts are starting to wonder about the friendliness of this beast.

What’s wrong with index funds?

Well, nothing really, or at least, they surely weren’t designed to be harmful. The proposed issue in question is one that was popularized by the infamous bear Michael Burry back in 2019, when he suggested that index funds were approaching bubble territory and the current way was becoming unsustainable.

The case against a bubble

It’s becoming about supply & demand, not growth: Investing in index funds is now common enough that a case could be made that returns aren’t coming due to company growth, but simply due to buyer demand driving up share prices over time.
Index funds could create an oligopoly on stocks: Even the inventor of the first index fund and Vanguard founder, Jack Bogle, was worried about the potential risk for the eventual concentration of ownership amongst big fund managers like Vanguard, BlackRock, and State Street.
Index performance bias: Although it’s not always the case, companies included in indexes often outperform those who are excluded, even if they narrowly miss the criteria. This can create a situation where the investment is more about brand inclusion than the company itself.
Indexes are inflating company valuations: Did that investor just invest in Apple, Microsoft, etc, or did they just buy into a fund because they were told to “buy and hold, it’ll be up a lot in 20 years?” There’s some evidence of this—just take a look at the adjusted P/E ratios for the S&P since $SPY, an S&P 500-based index ETF, launched. (The left chart is before the fund launched, the right chart is post-fund launch.)

The case for it

No negotiating? No big deal: One of Burry’s qualms was that passive index investors are skipping price discovery (or haggling for the best price), and essentially just settling for whatever the price ends up being, thus watering down the market’s ability to “fairly price” equities. The reality is that the overwhelming majority of trades (84% of them, in fact) are still done by active investors. So if you do value negotiation and some good ole’ limit orders, rest assured traders are still setting the prices, and passive investors are reaping the benefits.
Index funds also make for efficient markets: Index funds are able to charge investors low fees because they have so many stocks sitting there for the long term that they are able to lend them to short-sellers at low rates. So, they also contribute to making markets efficient even when most investors in them are “price takers.”
Conflicts of interest: People sounding the alarms about index funds tend to be asset managers with a more active investing approach. They tend to charge more fees due to the research and analysis needed to invest actively. And over a 10-year period, only 25% of all active funds even beat their passive counterparts.

💡 Here's a related lesson on this topic:

What is the S&P 500?

Investing Basics

6 mins

MONEY TIPS

Looking To Move To Another US State This Year?

Although moving is less commonplace than it used to be, there are still an estimated 40 million people in the US moving each and every year—that's 13% of the country resettling in a new state.

Moving can be extremely, and usually unnecessarily, complicated. Different states and jurisdictions have different, weird, and sometimes nonsensical laws, different taxes, different everything. And all of this makes up a long list of things to account for before moving.

Worry about marriage laws: In certain states, you might be inadvertently considered married to your partner after enough time. For states that also have “community property,” where your assets are automatically registered as owned in half by each spouse, this can create an even weirder financial situation upon “divorce” or death.
Property ownership: In the age of remote work, earning from a company based in one state and living in another can make it complicated for the IRS when tax season comes. Make sure you can compile convincing evidence that you did in fact move to another state. Proof of where your children go to school, where your car is registered and where your pets may have gone to the veterinarian may all come in handy in time.
Tax structures: We all know that different states bring different tax advantages and disadvantages. California has a 13.3% income tax rate, while Florida has no such tax. Louisiana has an average state and local sales tax of 9.55%, whereas Maine’s is just 5.5%.

🔥 TODAY'S MOVERS & SHAKERS

Expedia (-14.8%) is down today despite beating Analysts' top- and bottom-line estimates and Peter Kern's (CEO) optimism that there's pent-up demand; shares may be down as investors still consider that the travel company is still trying to catchup to its pre-pandemic performance and the lower-than-expected future outlook on travel from Hilton Worldwide (-3.8%)
Chegg (-30%) is a US education tech company that provides digital and physical textbook rentals, textbooks, online tutoring, and other student services. Despite mixed earnings results today, CEO Dan Rosensweig said students are choosing jobs over college resulting in a lower course load, or delaying enrollment in school given increasing wages and faster inflation.
Western Digital (+14.7%), a computer hard disk drive manufacturer and data storage company; shares are up as activist investor, Elliott Investment Management, urged the company to separate its Flash business and offered to invest $1 billion to facilitate a sale or a spin-off of the business
Bitcoin (BTC) -0.5% to $38,311.50
Ethereum (ETH) +0.2% to $2,823.02

This commentary is as of 9:00 am PDT.

🌊 BY THE WAY

Answer: It's 20%, as of yesterday's close. The top 1% or top 5 holdings in the S&P 500 Index are Apple (7%), Microsoft (6%), Amazon (3.1%), Tesla (2.1%), and Alphabet Class A (~2%) (SlickCharts)
👊 ICYMI. Myth Busting ETFs (Finny Bites)
🍕 The global pizza market is expected to reach $233 billion by 2023. And people want good food delivered fast. That’s why 800° GO has designed a fully-autonomous pizzeria to cook artisanal pies in just 3 minutes. Get your slice of the pie before the round closes on May 4th.
🤔 Most Americans could file their taxes for free, but don’t (AP)
Finny lesson of the day. Since we've covered a lot on the topic of passive index funds today, let's dive into what exchange-traded funds (ETFs) are all about:

What Are ETFs?

Investing Basics

6 mins

What did you think of Finny's The Gist today? (Click to vote)

Refer friends to Finny

Finny is a financial education platform on a mission to make your money work for you. We offer a customized financial learning platform through bite-size, jargon-free lessons, money trends & insights to teams & companies.

The Gist is Finny's twice a week (Tues & Thurs) newsletter covering personal finance & investing insights and money trends. Finny does not offer investment and stock advice or endorsements. The Gist content team: Austin Payne, Othmane Zizi, Chihee Kim.

We're thankful for our sponsors' support as they make rewards on our platform possible. If you're interested in sponsoring The Gist, please reach out to us. And if you have any feedback for us, please contact us.