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19th February 2024
What is the risk of investing only in the S&P 500? What particular considerations do you need if investing for an ARF?
Should you bet all your investment or pension assets on the good ‘ol S&P500? Or would you be considered ‘bananas’ to do so?!? As with a lot of my articles, this is inspired by a recent conversation. Conversations that I love to have and to explore with clients.
We are surrounded my American culture, and we are bombarded with it via most news, marketing and social media channels. Heck 🙂 half of the youngers in Dublin apparently speak with an American accent! The food we eat, the technology we engage with, the clothes we wear and the things we spend our time and money on are heavily influenced by the US. Like it or lump it.
But does that mean we should invest our pension or personal investments on the great companies of North America at the expense of investing in globally diversified companies? There is a strong case for and against. Like it or lump it!
When it comes to investing, the US S&P 500 index stands tall, drawing investors in with its reputation for stability and solid long term performance. Anyone that reads or listens to investing will invariably have read lots of stuff out of the US (because there is so little content from the rest of the world unfortunately), and the US folk do love investing in the S&P500, usually at the expense of investing in any other countries!
So we are therefore told all about how great a market it is to invest in, how it has returned fantastic returns over the long term – and that one simply doesn’t need to consider investing elsewhere.
And when you see from the chart below, since 1998 the sample S&P Vanguard Index has delivered 551% growth since 1998, versus a paltry 401% from a sample Vanguard Global Stock Index! And not forgetting that almost half of that timeframe includes the ‘lost decade’ of the noughties where the markets were ultimately fairly flat.
Big picture, you’d have been as mad as a box of frogs to have invested in anything other than the S&P 500 in the past couple of decades would you!?? It sure seems so on the basis of those returns. But is investing only in the S&P 500 really the route to take?
And the case for USA gets only stronger when you look at the Nasdaq 100, which invests in the top 100 non-financial companies in US. You can then argue that heck, we should have been all-in on the Nasdaq, never mind the broadly diversified S&P which invests in the top 500 of the US!
The Nasdaq has delivered bananas numbers with 1827% delivered by a Nasdaq 100 index since 2002 (start date of this fund), this sample from Invesco. Versus 755% from S&P500 and 600% from Global Stock Index.
As Matthew McConaughey might say; ALL-RIGHT ALL-RIGHT ALL-RIGHT!
Hot-damn! Could one say that a financial advisor is not doing right by their clients if they are NOT advising all their clients on investing only in the S&P 500 or the Nasdaq??!
Is going all-in on the S&P 500 really the smartest move for your investment and pension funds? Particularly if your goal is investing for an ARF? Let’s take a closer look at the pros and cons of this strategy to help you steer your financial bananas in the right direction.
One of the biggest draws of the S&P 500 and/or Nasdaq is its history of delivering solid returns over the long haul. Looking back, as we have done above, it’s consistently outperformed more globally diversified markets, making it a favorite among investors, in the US at least for now.
Despite its US-centric focus, the S&P 500 and Nasdaq will claim to offer a nice mix of industries under its roof. From technology, financial, utilities, pharma etc etc. Plus, the argument will be that these companies, while based in US are serving a global consumer-base.
Coca Cola is a US based company but derives it’s growth from new and established nations right across the world. Same with Microsoft or any other of the mega caps you wish to mention. They are not simply serving US consumers, therefore not reliant on US economy, they say.
This built-in diversification might suggest your investment isn’t overly reliant on the fate of any single sector or economy, which might help soften the blow if one area takes a hit.
With the US economy touted as being a powerhouse on the global stage, hitching your financial bananas to the wagon that is the S&P 500 or Nasdaq means you might be riding alongside some of the world’s most innovative companies for many years to come.
Sure, the S&P 500 is diverse, but it’s still heavily weighted towards certain sectors like tech and finance. Going all-in on the index means you’re banking a lot on the performance of these areas, which could leave your portfolio vulnerable if they hit a rough patch.
Could you potentially also miss out on growth opportunities in other regions over the long term? What happens if the US ceases to be a global powerhouse, if the tide turns on them?
Sure, the S&P500 and Nasdaq have been powering along in the past decade in particular, largely down to the super-caps. The current top 5 stocks in the Nasdaq are the following, and they alone make up c33%, a third, of the entire index! How will that index look if one or more of these companies’ fortunes change? This compares with c18% of a Global Equity index allocating to the top 5.
Recency Bias – Sub-note here.
Recency Bias is a fierce thing. We see something happening and we think it will remain that way for ages, and we’ll berate ourselves for not doing it sooner! We now see the US funds going gang-busters and we might think that we should have gotten onto that wagon sooner.
Even during the period of 1998 to today, which is 26 years, things have not always been the same. From 1998 to 2007 Globally Equity Index delivered almost double the rate of returns of the S&P500.
From end 1998 to 2000 they both rise 50-60%, then they plummeted of course. The Nasdaq fell 76% in 2002! Imagine that. Imagine you have a €1m balance in your (Nasdaq) ARF pension in January 2002, and by end of the year the balance is €240k. That is terrifying. Imagine you are drawing €60k per year from that pension pot to sustain you – now that’s simply unthinkably scary. You’d need your funds to recover quickly.
And which one did that most successfully? From December 2002 to December 2007 the Global Index grew by 60% while the S&P500 grew 30%, a full half less than the Global Fund.
Like any stock market investment, the S&P 500 isn’t immune to ups and downs. Economic shifts, global events, you name it – they can all send the index on a wild ride, potentially leaving investors feeling queasy, and seeing their bananas disappear before their eyes.
If you’re investing from outside the US, hitching onto the S&P 500 wagon can also means playing the currency game. Fluctuations in the US dollar can impact your returns, adding an extra layer of uncertainty to the mix. There are hedges and Euro funds but it cannot remove the currency factor entirely.
Instead of investing only in the S&P 500, I always encourage we consider a more balanced approach. If we don’t need to try achieve bananas returns, why chase it exclusively at the risk of exposing ourselves to the cons we can’t handle.
Perhaps mix things up by diversifying more globally. It’s not like we are ignoring US stocks by investing globally, as a market cap weighted Global Equity Fund will still have a very significant allocation to US stocks! Currently c70% of a Global Equity Fund is already allocated to the largest US stocks, as it is market-cap weighted. Difference here is the Global Index will alter these allocations as the market cap of countries fluctuate and rebalance.
Investing our pension or investment assets to the USA have its charms, no doubt. Investing all your funds solely in these stocks, whether via an index or directly isn’t without its risks however. It may be unadventurous for some but by taking a more balanced approach.
Perhaps spreading your equity allocation across different regions can better protect your bananas over the longest of terms? Particularly so if you are investing for an ARF, whereby your ARF will be invested for (hopefully) multiple decades.
We all want to be able to weather the storms and steer our financial ship towards smoother waters. Remember, it’s all about making informed decisions and keeping your eyes on the prize of long-term financial security and ensuring you have enough to retire. So, before you jump on the S&P 500 bandwagon, take a moment to consider the bigger picture and chart the course that’s right for ‘the future you’ as well as the ‘today you’.
Sure, the S&P and/or the Nasdaq may well continue to out-perform into the future, and you have to be willing to accept that. If you aren’t, then you do what you need to do!
ALL RIGHT ALL RIGHT ALL RIGHT.
Paddy Delaney QFA RPA APA
Informed Decisions are one of Ireland’s only remaining independent financial advice firms. We specialise in retirement & investment planning for successful individuals, so that our clients only have to retire once.
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