Cool Kids, Apple, and the NASDAQ 100
I was not one of the cool kids in high school.
Although, I think I was on the edge- with one foot in the door. The idea of cool kids explains a big issue that’s going on with stock investing, which I’ll get to in a minute.
I had my share of cool kid friends, but was not in the “inner circle”- not always invited to the cool kid parties. My high school class was 485 people- and I’d count about 35 to 40 of the total as the cool kids.
So, about 10% cool kids.
What going on with the NASDAQ 100?
The NASDAQ 100 is “a stock market index made up of 101 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock exchange. It is a modified capitalization-weighted index.”
Let’s break that down.
This index includes stocks from a variety of industries, including industrial, tech, retail, telecom, biotech, healthcare, and several other company types.
CNBC reports that, as of 7-20-23, the index has a 37% year-to-date return.
Great, right?
Well, hang on…
“The three biggest names appear to account for more than 30% of the index combined.”
What?!
At the moment, Microsoft makes up 12.67% of the total index, and Apple is 12.31%.
Truly the stock market cool kids.
How does this happen?
Well, the big tech stocks generate huge revenue and profits, more investors by the stocks, and the total market capitalization (number of share outstanding times share price) becomes massive.
The result?
These high performers become a biggest percentage of the index.
Why stock diversification matters
OK, so what’s wrong with getting most of the return out of a few stocks?
Because those few large stocks could also produce the bulk of the losses.
The reason to own an index fund (which invests to mirror an index) is to benefit from diversification. For example, if retail sector stocks decline due to bad news, you own lots of other stocks in different industries.
What to do next
The good news is that NASDAQ is rebalancing the index to provide more diversification. From the same CNBC article:
“Nasdaq said a special rebalance can be used to ‘address overconcentration in the index by redistributing the weights.’ The index is already rebalanced on a quarterly basis.
The special rebalance will help avoid a situation where issuers with individual weights above 4.5% account for more than 48% of the total index, as detailed in Nasdaq’s methodology. That limit is designed so that index funds tracking the Nasdaq 100 do not run afoul of regulatory rules governing the diversification of registered investment companies.”
NASDAQ will add up the value of stocks that make up 4.5% or more of the index. If that total is more than 48% of the total index, the index will be rebalanced again.
One more thing.
Discuss these issues with a financial advisor. Ask your advisor to provide a list of the top 10 holdings in the fund- along with the percentages of the stock’s market value in the fund. Ask questions about diversification.
Don’t depend on just a few cool kids- diversify.