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Capturing Returns – Diversification, Concentration, or Both? (Guest Post)

Capturing Returns – Diversification, Concentration, or Both? (Guest Post)

Dimensional did a study on the impact of diversification on the probability of outperforming the market benchmark. In this case, they are using the MSCI All Country World Index (which you can invest with the VWRA listed on the London Stock Exchange).

Diversification -

This post was originally posted here. The writer, Kyith Ng is a veteran community member and blogger on InvestingNote, with username known as kyith and has 1091 followers.

Not too long ago, there are talks that the markets have been hard-carry by the largest capitalized companies in the United States.

The worrying thing is whether this is healthy or not. I think over the years, Dimensional Fund Advisers have a few good research piece on this.

The largest holdings of the MSCI World index are currently Apple, Microsoft, Amazon, Facebook, and Alphabet. Together they make up 13.5% of the index. This is not too concentrated.

However, if we peep at the S&P 500, these 5 make up 22% of the index.

These indexes are market capitalization-weighted, which means as certain companies get stronger, their share price performs better, they get bigger, their returns drive the returns more.

Weight of the largest stocks by market capitalization in the US market from 1927 to 2019

Some companies stay on top for a long time:

  1. AT&T was the largest two for six straight decades beginning in 1930
  2. General Motors and General Electric was in the top 10 at the start of multiple decades
  3. IBM and Exxon were the mainstays for some time

Here is a clearer view:

Largest 10 stocks at the start of each decade

Prior to the 1980s, the larger companies were more dominant than today.

There is always another story to tell: There were a lot of dominant companies in the past. They dominate for decades. And now they are gone.

I am not saying that Apple, Microsoft, Amazon, Facebook, and Alphabet will falter. They have strong moats. They could stay for 3 decades and your investments in them would do well.

However, the lesson here is that its not that unsurprising for them to falter.

How Poor Would Your Performance bet if You Missed out on the Top Performers?

The FAANG stocks are represented by Facebook, Amazon, Apple, Netflix, and Google. For the past decades, if you have invested in them you would have done really well.

But how would the US broad market do without these FAANG Stocks?

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