Are Indexes in a Bubble?

In 2024, five stocks (Nvidia, Apple, Meta, Microsoft, and Amazon) provided 45% of the returns of the S&P 500.

Nvidia on its own was responsible for 20% of the S&P 500 returns.

We are now at a point where the top 10 stocks make up a very high percentage of the S&P index, so we are seeing a diversified index become increasingly concentrated.  The ratio in the chart below will not continue forever.

The problem with basic indexes like the S&P 500 is that they allocate to companies based on size, and when big companies get bigger, they keep buying more. We much prefer smart index funds that allocate to companies based on more fundamental factors such as profitability and cheap share price.

This approach prevents us from being over concentrated, and typically creates a smoother ride with less boom and bust. When we allocate more to companies based on factors like profitability, and value of the share price, we have higher expected returns.

Good investing is really a case of avoiding mistakes rather than doing brilliant things.

Charlie Munger (Warren Buffett’s right hand man) once said  " It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent."

If we can stay properly diversified and follow evidence of investing factors that consistently work, we can consider our investing approach to be consistently not stupid and this gives us an enormous edge.