By Ranga Srinivasan and Ramprasad Satagopan

As financial advisors in Cupertino, CA, Everest strives to provide guidance and education on wealth management matters. We hope this article sheds some light on your questions and concerns. 

The S&P 500, which represents the top 500 companies listed in the U.S. stock market, is a familiar investment strategy for most people. It has been on an impressive run for the past 12 years. This has led many investors to believe that this performance is normal, sustainable, and is even a safe investment. While the recent data is indeed compelling, it’s important to understand the limitations of this investment. 

The Pitfalls of the S&P 500 Index

The S&P 500 is a market cap weighted index where companies get included or excluded through a committee. The market cap weighting approach results in the top few companies being weighted highly, while the bottom companies have a very small allocation. As an example, Apple has a roughly 7% weight in the index, while Tapestry has only a 0.04% weighting in the index. This weighting results in concentration risk. While on the surface an investor is holding 500 companies, the weighting mechanism results in a greater reliance on the top 50-70 companies.

In addition to concentration risk, the S&P can often carry valuation risk. Valuation of the companies, as measured by the price-to-earnings ratio (PE ratio), varies from time to time. There are periods where the PE ratios are low (typically during recessions) and periods where the ratio is high (during an economic boom). Investing during periods of high valuation can often result in lower future returns when valuations revert to their long-term averages. The opposite is also true: when the S&P is going through a terrible phase, the valuations compress, and future returns might improve for the same reason.

With these two underlying risks explained, what does the actual data for the S&P 500 show? It is useful to study the S&P performance across three major down events, of varying time duration. COVID in early 2020, the Global Financial Crisis in late 2007 to early 2009, and the lost decade from Jan. 2000 to Dec. 2009.

  • The COVID crisis: The pandemic caused a sharp drop of 34% in just 33 days in early 2020.
  • The Global Financial Crisis in 2008 caused a setback that was both deep and long. There was a 57% drop from peak to trough when the entire financial system was on the verge of collapse. 
  • The Lost Decade: The period from 2000 to 2009 saw an extended decline for the S&P 500, due to multiple downturns, and resulted in a negative return of about -1% per year for the entire decade.
  • There are other documented periods in history where the S&P has trailed the 3-month T-bills for 15+ years!

The above comments are intended to remind investors how a familiar and strong investment can behave very differently from the recent past. 

It is important to also remember that during these crises, job losses will be pervasive, and portfolio risk is often additive to the risk of job loss within the family.

If a majority of the household wealth is invested in the S&P, such long and deep downturns can be very difficult to navigate, particularly for retirees and pre-retirees who will soon start depending on their portfolios to support their expenses. 

So what is the solution?

Diversification

Diversification, where investments are spread across different asset classes, is considered the only free lunch in investing.

While most people are familiar with diversification, it is important to recognize that diversification is a continuum that spans. 

* Generally, among asset classes, stocks are more volatile than bonds or short-term instruments. Government bonds and corporate bonds have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns. U.S. Treasury Bills maintain a stable value if held to maturity, but returns are generally only slightly above the inflation rate.

With each extra level of diversification, we can increase downside protection along both the magnitude and duration perspectives. Well-diversified portfolios can drop less, and recover faster than more concentrated portfolios. This will allow investors to sleep better at night and be confident that their retirement plans can succeed. But this does come with a trade-off where a well diversified portfolio can substantially lag concentrated portfolios, sometimes even for many years at a stretch. 

The Case for an All-Weather Approach

By diversifying across multiple asset classes, investors can build a portfolio that is designed to weather various market conditions. This approach may help:

  • Offer better protection during deep market downturns
  • Reduce overall portfolio volatility
  • Provide more consistent returns over time

While the S&P 500 remains a valuable component of many portfolios, it is important to recognize its limitations. A well-diversified, all-weather portfolio can help investors navigate the unpredictable nature of financial markets with greater confidence and resilience.

Remember, investing always involves risks, and past performance doesn’t guarantee future results. It’s crucial to align your investment strategy to a long-term financial plan that aligns to your personal financial goals, risk tolerance, and time horizon.

We at Everest Management Corp are here to help. Are you interested in learning more about how we can help you pursue your financial objectives in any climate? Schedule an introductory, no-obligation meeting by contacting us at 408-502-6015 or emc@everest-mgmt.com.

About Ranga

Ranga Srinivasan is co-founder and principal at Everest Management Corp, an SEC-registered wealth advisory firm based in Silicon Valley and serving clients across the United States. After graduating from the University of Cincinnati in the field of engineering, Ranga, witnessed the dot-com collapse in the early 2000s and sought to manage his own personal finances. He realized that many of the options available were unsatisfactory for a myriad of reasons. Knowing it could be done better, Everest was founded in 2007 to provide comprehensive wealth management. Ranga and the Everest team are dedicated to caring for the financial needs of the families they serve. With an emphasis on building trust and holding to the fiduciary standard of putting clients first, Ranga strives to offer financial solutions that inspire confidence. 

In his free time, Ranga is passionate about staying active; you can often find him swimming, golfing, biking, and playing tennis. He also has a great love for charity and philanthropy work. To learn more about Ranga, connect with him on LinkedIn.

About Ramprasad

Ramprasad Satagopan is co-founder and principal at Everest Management Corp, an SEC-registered wealth advisory firm based in Silicon Valley and serving clients across the United States. As a self-made, highly educated first-generation immigrant, Ramprasad became passionate about investing after witnessing the dot-com collapse in the early 2000s. He created Everest to help his peer engineering community to build household wealth in a systematic way. Everest has grown over the years while staying true to its fiduciary commitment. Ramprasad and the Everest team take pride in being a firm that brings a reputable, honest, and caring approach to all its clients.

Ramprasad graduated from both the University of Cincinnati and the University of Phoenix with a master’s degree in science and business administration, respectively. When he’s not helping families build a strong financial future, Ramprasad can be found enjoying traveling and reading. To learn more about Ramprasad, connect with him on LinkedIn.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These views may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Investing in REITs involves certain distinct risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the quality of credit extended. REITs are subject to heavy cash flow dependency, default by borrowers and self-liquidation. REITs, especially mortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, the value of the REIT may decline).

No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. The principal risks of Everest Management Corp. strategies are disclosed in the publicly available Form ADV Part 2A. 

Everest Management Corp. is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Everest Management Corp. and its representatives are properly licensed or exempt from licensure.