Big bets may pay off – if you bought Google when its initial IPO became available in August 2004 you made 1,400%. And this was shortly after the Internet bubble of 2000. Everyone wants big gains but they are not common. Your best bet is to diversify your portfolio. But do it smartly to get the highest return possible and still get a shot at some of those high flyers.
With fears in 2016 of stock market volatility, many are suggesting to buy gold and collectibles like gold coins. An instant way to get instant diversification is by buying an index fund like the Dow Jones or S&P 500 ETFs. These baskets of stocks though are cap-weighted – you end up owning more of the biggest companies within the basket – in the S&P 500, Apple has a market value or “market cap” of ~$607 billion and is given a higher weighting of 3.25% of the index compared to Mattel with a market cap of $11billion and a .06% weighting.
By buying equal weighted index funds, you get better returns with the same risk. For example in the current bull market, the S&P equal weighted fund rose 282% compared to 200% of the cap weighted funds. Equal-weighted means that every stock in the S&P 500 has the same weight in the index — 0.20%. Big stocks and smaller stocks are treated equally. In a bull market, most stocks are going up. So the equal-weighted index goes up more than the market-cap-weighted version because in many cases smaller stocks will make sharper, faster moves higher than larger stocks.
You definitely want big stocks in your portfolio. But you want newer, fast-growing stocks that can zoom up like Google too. If you use smart diversifying tools such as an equal-weighted index fund, you get the best of both worlds — the safety of big stocks and the growth of newer, smaller companies all in one.
An example of an exchange-traded fund (ETF) for the S&P 500 that use equal weighting is the Guggenheim S&P 500 Equal Weight ETF (NYSE Arca: RSP). For diversification among 1,000 companies, there’s the PowerShares Russell 1000 Equal Weight ETF (NYSE Arca: EQAL).
Fidelity’s competitors immediately felt the heat. Shares in BlackRock, the world’s largest asset manager and largest provider of passive exchange-traded funds (ETFs), closed 4.7% down on the day, as shareholders digested the implications for its business model. Those in Invesco, the fourth-largest ETF provider, dropped by 4.2%, and those in State Street (which, though the third-largest ETF provider, also has many business lines besides asset management) by 1.2%.
Competition had already driven charges on index-tracking mutual funds and ETFs to very low levels. The fee for the index-tracking mutual fund at Vanguard most similar to Fidelity’s new offering is 0.14%, and its ETF version costs just 0.04%. Charles Schwab’s corresponding offerings cost even less: both the mutual fund and ETF cost just 0.03%. There are economies of scale in index investing, since costs do not rise in line with assets under management.
Without skimming any explicit fee from the new funds, Fidelity will have to find other ways to make money, such as by lending shares to short-sellers for a consideration. It may also see the new funds as loss-leaders, hoping that investors will eventually migrate to its other offerings. To make that more attractive it has cut fees for its existing stock and bond index funds by around a third, which will save investors $47m annually, and done away with minimum investments across the board. And it surely hopes it will be able to “upsell” customers more lucrative products, such as financial advice.
That it was Fidelity that went to zero first was something of a surprise. Its reputation was made on the prowess of its stockpickers. The move therefore reveals just how much active management in shares is suffering. Over the past decade, an average of 87% of actively managed American equity funds underperformed their benchmark indices. Average active-management fees in 2017 were 0.57%.
Active-only asset managers have tried to respond to pressure from passive funds by consolidating. Examples include mergers between Janus, an American fund house, and Henderson, an Anglo-Australian firm; and in Britain, between Aberdeen Investments and Standard Life. But it is hard to see a reversal of the shift toward passive management, which, by some estimates, already approaches half of all assets in managed American equity funds. Fidelity’s move is likely to prompt further consolidation among passive-fund providers, too, even though many are already giants. After all, to make a decent income from such activities as lending shares to short-sellers means doing it at scale.
In recent years Fidelity has lost business to rivals who had moved earlier to focus on passive investing and to squeeze costs. It was already shifting its emphasis. In June a net $5.6bn flowed into its passive fund offerings, even as $2.6bn net flowed out of its active strategies. Its new zero-cost funds will surely accelerate this trend.
The price war in asset management was already fierce. Will anyone go to the wall? At the very least, it is hard to imagine that Fidelity’s rivals can hold off from lowering or even scrapping their fees, too. As free current accounts show, once something is provided for nothing, it is very difficult ever to start charging again.