The S&P 500 had a solid performance over the last five years, surging over 85%. Considering that time frame includes the pandemic-induced crash and the 2022 inflation sell-off, I'd say that's a good overall performance.
There are 11 sectors in the S&P 500. Yet only one sector, technology, has gained more than 85% over the last five years. You may be wondering, if the S&P 500 reflects the average performance of all 11 sectors, shouldn't around half of the sectors beat the market and half underperform? That would be true if each sector was similarly weighted and there weren't big outliers. But over the last five years, the technology sector has been an outlier for multiple reasons.
Here's why tech is carrying the market, and the impact it could have on your investments.
Image source: Getty Images.
Market leadership
The following chart is one of the most fascinating ones I've seen in a while.
The tech sector has been fantastic in the last five years while the other 10 sectors have all underperformed the S&P 500. What's particularly interesting about this fact is that Alphabet and Meta Platforms, two incredible performers, are actually in the communications sector while Amazon and Tesla are in the consumer discretionary sector. Yet even with those heavily weighted outperforming stocks, both the communications and consumer discretionary sector still underperformed the S&P 500 over the last five years.
The Vanguard S&P 500 ETF (VOO 1.26%) mirrors the performance of the S&P 500. It's a good way to see what makes up the S&P 500, both in terms of individual holdings and sectors.
As of Jan. 31, the information technology sector makes up a staggering 29.5% of the Vanguard S&P 500 ETF, which is more than utilities, real estate, materials, energy, consumer staples, and communication services combined. What has happened over the last five years is that the highest-weighted sector also happened to be (by far) the best-performing. The combination of outperformance and sector weight allowed for 10 out of the 11 sectors to underperform the S&P 500.
A highly concentrated market
I think it's a mistake to downplay this impact on the broader market and your own portfolio. If you weren't invested in big tech-like stocks over the last five years, there's a good chance you underperformed the market. There have been non-tech focused sectors that have put up respectable returns as well, namely industrials and healthcare. But overall, there are really two sides of the market.
Investing in an S&P 500 index fund is a big bet on the tech sector and market leaders in other sectors. Moreover, it's worth mentioning that the 10 largest companies in the S&P 500 make up 30.7% of the index. Those companies are Microsoft, Apple, Nvidia, Amazon, Alphabet, Meta Platforms, Berkshire Hathaway, Tesla, Broadcom, and Eli Lilly. In other words, the S&P 500 is going to live or die by not just tech but these top holdings.
NYSEMKT: VOO
Key Data Points
A lot of the slightly smaller heavy hitters are closely correlated to these top names. For example, another 2% or so of the S&P 500 is in Visa and Mastercard. An additional 2% is in Adobe, Salesforce, and Advanced Micro Devices. As you go down the list of S&P 500 components, you'll quickly realize just how much of the index depends on the performance of a relatively small number of companies.
Using (or not using) the S&P 500 as a benchmark
Aside from sector allocation, massive companies versus everything else is another important point to consider. If you're investing mainly in non-megacap stocks, then your performance will likely have nothing to do with the broader market's performance because the market is so top-heavy.
Ultimately, I think the key takeaway is that you could be heavily invested in the stock market and loosely correlated to the S&P 500. But if you own a lot of tech or megacap stocks, your performance could more closely resemble the S&P 500.
The new normal
I think it's time investors reset expectations and understand that the S&P 500 is no longer representative of the broader market, but rather, is heavily influenced by a couple dozen companies and the tech sector. Participating in the stock market can mean completely different things for different investors. And holding yourself to a benchmark like the S&P 500 may be misleading and inaccurate.
Ultimately, market dynamics don't mean nearly as much as achieving your financial goals. The key is to invest in companies that match your risk tolerance, that you truly understand and believe in long term, and that can compound in value over time.
Just know that you can find yourself grossly outperforming or underperforming the S&P 500, depending on your exposure to the tech sector.
