If you dabble every now and then in stocks and shares, you must have been wondering where to invest: AI related stocks are so expensive that you will be forgiven for thinking that the odds of a market correction are getting too high to ignore.
And then there are your ‘investments’ where you don’t control the asset allocation, such as your pension fund for example (Americans can make some selection of asset classes but not usually individual stocks and funds depending on their employer’s 401k plan).
So where to place your hard earned dough? The obvious choice then is index funds, which should represent the whole stock market and therefore give you exposure to the wider economy. But the emphasis here is on ‘should’ as unfortunately they don’t.
Take the American S&P500 index, which is officially defined by S&P Dow Jones Indices as an index designed to measure the performance of the large-cap segment of the U.S. equity market and is intended to represent approximately 80% of available market capitalisation.
But it doesn’t quite work that way. The S&P 500’s top 10 holdings (Nvidia, Apple, Microsoft, Amazon, Alphabet, Broadcom, Meta, Micron, Tesla and AMD) account for roughly 37.8% of the entire index. As you will no doubt have realised, with the exception of possibly Tesla – and that’s a question of interpretation – all of these are tech stocks. An index which is supposed to represent the larger US economy is hence to no minor part a play on technology.
And that’s not an exception. In fact many major and well known indices around the world suffer from some sort of bias towards certain industries. Roughly half of the U.K’s FTSE 100 index consists of stocks in the financial, energy and industrial sectors. Or in Switzerland’s SMI index (which consists of 20 stocks only) two pharmaceutical stocks (Novartis and Roche) and Nestlé (food) also represent about half of the index. So the SMI is effectively a combination of pharmaceuticals/healthcare and consumer staples, with relatively little exposure to industry and technology. Taiwan’s TAIEX is arguably an even more extreme example: owning the index gives you a substantial implicit bet on semiconductors and the global electronics supply chain.
You can see where I am going with this: you can’t necessarily rely on so-called indexed funds to create an investment portfolio representative of the wider economy rather than the stock market. But there may be one simple (albeit not perfect) solution: a single low-cost ETF that tracks the global stock market. And there are several of these listed in Europe and the US (since I am not qualified to give investment advice I won’t mention specific products).
One caveat though: a world equity ETF represents the listed corporate economy, not the entire economy. It will under-represent small private businesses, private equity, residential property and some government activity. But it is probably the closest you can get in a single investment product. There are a wide selection of listed investments vehicles available, which cover a wide range of these alternative markets. You might even, for a small portion of your overall portfolio, consider some emerging market fund (I hear that some of the African stock markets are all the rage these days).
And of course a balanced investment strategy also should include some bonds. Again, as with equities, there are some global bond funds which could give you an exposure to various currencies.
It is inherently difficult – as well as potentially time consuming and costly – to create a portfolio which is truly representative of the economy. Moreover, in the context of expected higher inflation and interest rates, both equities and bonds suffer. Conventional wisdom has it that equities and bonds move in different directions (a negative correlation), but one long-run analysis by Morgan Stanley going back to 1870 found a positive stock/bond correlation (both moving in tandem) in 78% of years. This is one reason why some investment advisers question the rationale behind the traditional 60/40 portfolio.
So by all means continue investing your money. In the medium to long term at least your returns are likely to outperform inflation. Just be aware of the shortcomings of the various strategies and allocations. There is no perfect investment strategy—only different ways of being wrong, at different times.
