Fear of FAANG

After a disappointing second-quarter, Facebook’s stock value declined by more than 20% on Thursday alone. Although it is just one example, the plummet in Facebook’s value shows how sensitive investors are to bad news, especially in relation to large growth technology companies.  The same can also be said for the rest of the FAANG giants.  Together, these five stocks (Facebook, Amazon, Apple, Netflix, and Google) currently have a market value of $3.37 trillion.  In total, they now represent 14% of the total market capitalization within the S&P 500.

While the increased market value is great for investors who got in on the ground level, it may not be such good news for a typical index-fund investor.  Due to their large market cap, many S&P 500 indexes are heavily reliant on these companies, meaning they are not truly as diversified or weighted as some investors may want.  To that effect, the traditional S&P 500 index, such as SPX, may not be the best choice for the everyday investor.

On the other hand, other index funds exist that provide a greater deal of diversification. They also limit risk due to a smaller reliance on a handful of stocks.  One example is Invesco S&P 500 Equal Weight ETF (RSP).  This index fund holds equal portions of all companies that make up the S&P 500. Looking at the performance of one the Invesco ETF versus SPX, it becomes clear that the long-run return of the more diversified fund yields a greater performance.  While the average one-year, three-year, and five-year returns for SPX are greater than Invesco fund, Invesco outpaces SPX on a ten-year and fifteen-year time horizon.

In determining which of these types of funds is right for you, it is important to determine the amount of risk you are willing to take.  Clearly, the SPX fund is riskier as it places more of its emphasis on the larger or higher market value companies.  Again, these would be the FAANG companies.  If the technology industry were to hit a large setback, its likely this fund would greatly decline.  Often, younger investors with more time in front of them have a larger appetite to take on risk and thus may more likely choose the SPX.  On the other hand, Invesco is a better choice for investors who are looking for a guaranteed positive return on their investment.  Either way, it is clear that investing in an index fund which tracks the S&P 500 is a great way to provide some level of diversification and achieve growth.

Today there are several good options that exist for an investor to track the S&P 500, both at a weighted scale or based on market value.  Beyond the two previously discussed some of the most popular S&P 500 Index Funds are the Vanugard 500 Index (VFINX), Fidelity Spartan 500 Index (FUSEX), Schwab S&P 500 Index (SWPPX), and the T. Rowe Price Equity Index Fund (PREIX).  All of these funds have a beta close to one, meaning the match the market, and have low fees due to the size of the companies which manage them.

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