Last month, Nvidia (NVDA) became the first publicly-traded company to reach a market cap of more than $4 trillion. And earlier this month, it became the largest stock in the S&P 500 index by weight.
The index consists of around 500 of the largest publicly-traded U.S. companies by market cap, but Nvidia accounts for roughly 8% of its value, even after yesterday’s decline. No stock has ever held more influence over the S&P 500 since the start of weighting data in 1981.
Nvidia is now the top dog in the S&P 500, but it’s not the only tech stock that makes up a disproportionate share of the index. The top 7 stocks, all of which are in the technology sector, now account for about one third of the index by market cap.
If you zoom out a little bit, the top 25 stocks in the S&P 500 now account for about 50% of the index by market cap. Most of that list is also tech stocks, although it also includes financial services companies such as J.P. Morgan Chase (JPM), pharmaceutical companies such as Eli Lilly (LLY), energy companies such as Exxon Mobil (XOM) and retailers such as Walmart (WMT).
This level of concentration raises an important question for investors: What’s the point of investing in index funds if most of their value is made up of a small handful of stocks?
Index funds vs. blue-chip stocks
The best investments for you will depend on your specific circumstances, and it’s always a good idea to check with a financial advisor before making any changes to your investment mix.
But the difference between buying index funds and just buying blue-chip stocks ultimately comes down to your risk tolerance, as well as how much you care about fees and income.
The advantages of individual blue-chip stocks
Higher potential returns. Investing in an index fund gives you that index’s return, while investing in individual stocks gives you the chance at index-beating returns (albeit with more risk). Case in point, the S&P 500 is up more than 9% this year. Nvidia is up around 27%.
Lower fees and minimums (usually). Now that many brokers have eliminated trading commissions and offer fractional shares, it’s possible to invest in individual stocks for just a few dollars, and pay nothing more than the market price for the amount of shares you’re buying. Mutual funds and ETFs, by contrast, have expense ratios, and many mutual funds still have investment minimums.
The advantages of index funds
Diversification and lower volatility. Individual stocks may go up more than index funds when times are good, but they can also go down more than index funds when times are bad. The smaller stocks in the S&P 500 can cushion your portfolio during periods of volatility. Between Jan. 23 and Jan. 27, Nvidia shares plummeted by nearly 20%, but the S&P 500 only dipped by 1.74%.
Dividend income. There are a few dividend-payers among the top 7 stocks listed above, but none currently have a yield of more than 0.85%. The SPDR S&P 500 ETF generates more income for investors; it has an average dividend yield of 1.08% over the last month.
More on buying stocks and funds
The author owned shares of the SPDR S&P 500 ETF at the time of publication.