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S&P 500 notches new highs. Where to invest in case of a pullback
The S&P 500 had a record close on Monday and continued to climb during Tuesday morning trading.
While headlines that the large-cap index has notched a new high have become the norm, some investors may wonder if a pullback is coming.
“The S&P 500 is broken,” said Michael DeMassa, who is a certified financial planner and chartered financial analyst, and the founder of Forza Wealth Management in Sarasota, Florida.
Many investors assume investing in the S&P 500 index — through ETF ticker symbols SPY, VOO or IVV — is synonymous with diversification, DeMassa said.
Yet that sense of safety is an illusion, he said, since the market capitalization-weighted index means companies with bigger allocations may drag down the fund if their performance suffers. Or the index’s heavy concentration in the technology sector may prompt volatility to ripple through the entire index, DeMassa said.
If you can invest in the S&P 500 index for a long time, you will probably do well, said Deva Panambur, a CFP and CFA, and founder of Sarsi LLC in West New York, New Jersey.
But occasionally the index suffers long periods of underperformance, he said. For example, between 2000 and 2008, the S&P 500 was down by more than 30%.
Wall Street forecasts generally see the index continuing to go up for the foreseeable future.
Still, experts say it’s best to choose a broader investment mix in case there is a pullback.
Other funds may offer broader exposure, experts say
For investors who are seeking a simple approach, it may make sense to opt for a total market index fund instead of an S&P 500 index fund, according to Brendan McCann, associate manager research analyst at Morningstar.
Unlike S&P 500 index funds, total market funds also provide exposure to small- and mid-cap stocks in addition to large-cap companies.
Alternatively, investors may opt to broaden the exposure an S&P 500 index fund already provides in their portfolio. One example may be a fund that tracks a total market index that excludes S&P 500 index stocks, or the Vanguard Extended Market ETF, according to McCann.
The trick with that strategy is to buy the funds in the right proportion, McCann said.
For investors who don’t want to worry about changing their asset allocations over time, buying a total market index fund may be a better approach, according to McCann. Switching to a total market index fund strategy may be particularly attractive for investors who don’t have to worry about the tax implications of changing funds, such as 401(k) investors, he said.
Other experts have recommended opting for equal-weighted S&P 500 index funds, which hold an equal proportion of each stock. However, the downside with those strategies is that there may be more transaction costs when rebalancing, McCann said.
Watch for overlapping funds that can add risk
When the S&P 500’s returns were down between 2002 and 2009, areas like small cap, value, international and even bonds performed better than that index, Panambur said.
Today, the portfolios he creates for clients have allocations to those areas.
“When I look at the overall allocation, my goal is to make sure it’s more balanced than the S&P 500,” Panambur said.
The set-it-and-forget-it S&P 500 strategy was intended to provide broad market exposure. “That’s no longer the case,” DeMassa said.
As investors seek to diversify, it is important to pay attention to the holdings of each of the funds they own, he said.
If a portfolio has funds tracking both the S&P 500 and Vanguard Growth indexes, for example, the exposure to large-cap technology names will be increased rather than limited, he said.
