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Why the S&P 500 (.INX)’s Record High Isn’t as Important as You Think: Bank of America Corp (BAC), Wells Fargo & Co (WFC)

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Yesterday, the S&P 500 (INDEXSP:.INX) hit a new record high for the first time since 2007. In light of all the other market benchmarks that have been setting records left and right lately, the addition of the S&P 500 (INDEXSP:.INX) might not seem to be all that big a deal; but many analysts have argued that the S&P’s record has special significance.

S&P 500 (INDEXSP:.INX)

Despite the hype, the S&P 500’s record close yesterday shouldn’t lead you to make any monumental moves in your portfolio. Here are some reasons why:

1. The S&P isn’t as broad-based an index as it looks.
One of the big arguments in favor of using the S&P 500 (INDEXSP:.INX) as the leading measure of the U.S. stock market is that it includes a wide set of companies. With 500 of the largest companies in the nation, the S&P 500 (INDEXSP:.INX) fairly represents the breadth of the U.S. economy, including proportionate exposure to every industry in the market. That differentiates it from other popular indexes like the Dow and the Nasdaq-100, each of which tends to have skewed exposure toward certain industries and companies, and away from others of arguably equal or greater importance.

But, when you look more closely at the S&P 500 (INDEXSP:.INX), you’ll notice that a relatively small number of companies are responsible for a huge part of its overall value. The top 10 stocks in the index account for nearly 19% of its value, and its largest component has a weighting of more than 3%, compared to just 0.01% for several of its smallest components. That makes the index highly dependent on megacap stocks, and has led some investors to use equal-weight funds in lieu of the market-cap weighted S&P 500 (INDEXSP:.INX).

2. The S&P’s index value doesn’t reflect its actual returns.
Many investors rely too much on closing values of indexes as gauges of their returns. Yet, two big factors that have an impact on returns routinely get ignored by those focusing solely on index levels.

On one hand, dividends aren’t reflected in the S&P’s closing record. With a yield of roughly 2.1%, investors who’ve relied solely on index funds tracking the S&P 500 (INDEXSP:.INX) have earned a modest, yet substantial, positive rate of return since late 2007, even if the index’s value is almost identical to its former closing high. Alternative market measures incorporate total return, but those measures aren’t among the popular benchmarks investors are most familiar with.

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