Why Top-Heavy has Risk.
One of the worst mistakes a ship designer can make is to build a ship that has more weight in the wrong places. If a ship is top-heavy, a rough sea can spell disaster for that vessel. Recently I discussed the risk associated with the cap-weighted S&P 500 index and the related index mutual funds and index ETFs associated with that index. But even with greater diversification, this risk does not disappear. The NASDAQ Composite is very diversified but is also potentially a ship with higher risks.
What is the NASDAQ Composite?
The Nasdaq Composite (Ticker symbol IXIC) is a stock market index that includes almost all stocks listed on the Nasdaq stock Exchange. Along with the Dow Jones Industrial Average and S&P 500, it is one of the three most-followed stock market indices in the United States. The composition of the NASDAQ Composite is heavily weighted towards companies in the information technology sector. Furthermore, this index is a capitalization-weighted index. This means the bigger companies make up a considerable portion of the overall value of the index. This may skew your diversification in an undesirable fashion.
What Should You Do?
If you haven’t already done so, you should examine your retirement portfolio to see if the mutual funds or ETFs you hold have a lot of overlap in the biggest companies. If you see overlap, then be aware that you might be increasing your risk. For example, if you own three mutual funds, and AMZN is in the top ten of all three, then your risk might be more than you imagine.
There are always five things I consider when buying a mutual fund or ETF. The first is the dollars invested in the fund. If it is less than $1 billion, I tend to avoid it. 2) If the expense ratio is greater than 0.10%, I want to know why the higher cost is merited. 3) What are the top ten investments and is there overlap with other funds I already own? 4) What is the ten-year performance of the fund? 5) Do the top ten investments in the fund contain 20% or more of the total investments. There may be 1,000 companies in the fund, but if 20% of the dollars are in the top ten, this increases your potential risk.
My Free Services
For those who are interested, I am always willing to do an analysis of your retirement investments. This usually takes me less than 30 minutes. There is no cost to you. I do this to help others learn how to better understand and manage their existing investments.