The S&P 500 index is the most popular large capitalization stock index in the U.S. It includes the 500 largest stocks in the U.S. and is diversified across a broad cross-section of different industries. It is a “capitalization-weighted” index, meaning the composition mix of stocks is weighted by the market capitalization of each stock in the index. For example, Microsoft (MSFT) currently has a market cap of over $1 trillion dollars (equaling its current share market price times its current shares outstanding). This huge market cap influences its weighting in the S&P 500 index; it currently has a weighting in the S&P 500 index of just over 4%!
In fact, there are many other “mega-cap” stocks that also hold a large position in the S&P 500 index. Other large names include Apple, Alphabet, Amazon, Facebook, Berkshire Hathaway, JP Morgan, Johnson & Johnson, and Procter & Gamble; mostly stocks with a “growth” bias. The top 10 holdings in the S&P 500 make up 22.1% of the index.
To the extent that these largest stocks in the index perform either well or poorly will impact the results of the index disproportionately. Over the last three years, “large growth” stocks have had a great run as shown by their 16.0% compound annual return on the chart below (shown by the growth ETF, IVW) compared to the S&P 500 return of 14.1% (SPY) and the S&P 500 on an “equal-weighted” basis return of 11.8% (shown by the equal-weighted ETF, RSP, where each stock in the index holds a 1/500th weighting).
Though it is nice to capture the “upside” of the large overweight to “growth” stocks, it will not be so nice to experience the downside risk that is sure to follow it someday; growth stocks tend to exhibit more volatility of return than the S&P 500. Best to stay broadly diversified across all market sizes and characteristics to capture the inflection points when they occur.