In a few weeks the S&P 500 will witness a large reclassification, the likes of which hasn’t happened in over 17 years.
This will have a big impact on certain investors and almost no impact on others. But that won’t stop some folks in the media from trying to blow it out of proportion. (They need something to write about after all.)
I thought I’d take three minutes and explain what’s going on and why.
You can either read my update or watch my three-minute video:
What’s Changing?
In mid-September, real estate will become a key sector in the S&P 500. Presently, it is not.
As a result of this shift, the existing sectors will have a lower weighting. Included in the real estate sector will be companies that build homes, apartments and commercial property of all kinds.
The S&P will rebalance its indexes on September 16th to reflect this change and index funds which track the S&P will follow suit shortly thereafter.
But keep in mind that real estate companies are already included in the S&P. This change simply re-classifies these holdings so that real estate will be a stand-alone sector.
Presently, real estate stocks are included in other sectors like the financial, technology and utility sector. Now, real estate will have its own place at the table. This will make real estate holdings easier to track – that’s it.
For people who have broadly based funds, this is non-event. For people who invest in narrowly based sectors, the impact could be huge. But it’s an important wake-up call for everyone. I’ll explain why in just a minute.
Why is this happening?
The decision makers at Standard and Poors understand how important real estate is to the global economy. In many markets, property values have performed well and compete nicely when stacked up against equity markets.
Also, real estate has been a good way to diversify holdings and spread risk.
Of course real estate investments typically provide investors with attractive dividends. But because those real estate holdings are already held in the S&P, people who hold the broad index won’t see a dividend increase.
Why this is important to you.
As I said above, people who hold broadly based indexes probably won’t even notice the change. But that’s not where the story ends.
Most investors think of the S&P 500 as a static investment. But this move shows it isn’t anything of the kind. You may not know it, but some holdings within the index change every year and major overhauls like the one we see now occur from time to time as well.
Therein lies the big take away from what’s happening.
If you take a step back, you’ll see that this demonstrates the importance of paying attention to the market and change holdings accordingly. That’s what the people at Standard and Poors are doing right now. That’s what they do every year. And that’s what I have been suggesting you do as well for years.
If you hear a commentator try to make this shift into something, it’s not – just change the channel.
How to Pay Attention to The Market the Right Way
In my experience, it pays to pay attention to the market and shift holdings accordingly. There are a number of ways to do this and none are perfect but in my experience, it’s far better to do this than ignore the market.
One way is to look at the performance numbers of various indexes over different time frames and assign a weighting to each return. Then you add up the scores for each period and focus your investments in those indexes with the best scores.
Here’s an example of why this is so important. Look at the chart below. It shows the S&P 500 (gold line) underperforming European markets (black lines) for 3 years.
If you invested $100,000 in the S&P during that time and ignored underperformance you’d be kissing $40,000 goodbye. Harsh.
Of course this is historical and that doesn’t guarantee future results. But can you see why I harp on this? It’s dangerous to do anything while ignoring your surroundings – the same goes for investing Pilgrim.
Of course, I suggest you also measure market strength and only invest during periods when the market is exhibiting strength.
You should test various methods to do this and make sure your strategy makes sense over the long run (and over various market cycles) before implementing such a strategy.
Bottom line? You might see or hear some wild claims with regards to this upcoming change in the S&P 500 but it’s really something most of us can ignore.
What you should not ignore however is your investment performance and overall market strength. Both have a huge impact on your overall investment success.
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