Weekend reading: beautiful concentration edition

A reader wrote in an apt question this week: Many of us are at that stage of our financial lives where the risk of sequence of returns is high, and it feels like our portfolios are increasingly at the mercy of a handful of tech giants.

The question was whether it is possible to reduce or eliminate exposure to the “Magnificent Seven” stocks without giving up the diversification benefits of broad-based ETFs.

Let’s start with what’s driving this concern. The combined market value of the Magnificent Seven (Nvidia, Microsoft, Apple, Alphabet, Amazon, Meta and Tesla) is now over $19 trillion, representing approximately 36% of the S&P 500’s $54 trillion market cap.

That is more than double their weight in 2022 and triple their share eight years ago. By the end of 2025, the top ten stocks made up nearly 40% of the index, surpassing the internet-era high concentration of 20 percent and marking the most top-heavy market in modern history. Nvidia alone has a weight of about 8% in the index.

That kind of dominance shows up in ETF lineups. In a simple S&P 500 tracker like VFV or VOO, these three largest names – Nvidia, Microsoft and Apple – account for more than 21% of the total shareholdings.

In a global equity fund like VEQT or XEQT, the same three represent only about 7.5%, because the exposure is spread across Canada, international developed markets and emerging markets. That’s the beauty of global diversification: it naturally dilutes risk to one country and one sector.

For investors who want to take concentration a step further, there are a few options:

Equal weight ETFs like Invesco’s S&P 500 Equal Weight ETF (RSP), they hold the same companies, but they all give the same leverage, rebalancing quarterly. This reduces risk for individual stocks, but leads to higher turnover and could seriously lag if megacaps dominate, as they will in 2023-2025.

Ex-Mag 7 ETFs go one step further. Defiance’s Large Cap Ex-Mag 7 ETF (XMAG) simply removes those seven names. That’s a bold bet: It may protect you in a recession, but you’ll underperform if the leaders stay ahead.

There is even direct indexinga newer strategy that Wealthsimple is now offering to retail investors. Instead of owning a fund, you own dozens or hundreds of individual stocks that make up an index. It allows for tax loss harvesting, customization and the ability to reduce exposure to specific companies (the most obvious being your own employer’s shares).

The tradeoffs are higher cost, complexity, and the potential for tracking error if you exclude the wrong names.

Yet my boring standard answer remains the same: own the world with a single global stock fund like VEQT or XEQT. You’ll still pick up the winners, but it’s not likely that one company (or seven) will make or break your portfolio.

And here’s the twist that is often overlooked. Research by Hendrik Bessembinder shows that only 4% of stocks are responsible for all net wealth creation in the stock market. If you miss those winners, your long-term returns will suffer far more than your profits if you avoid a few laggards.

Even if current valuations seem too high, trying to outsmart which companies will generate next-generation returns is a fool’s errand.

So the takeaway for this weekend: It’s okay to feel uneasy about the Magnificent Seven’s hold on the market, but diversification – not exclusion – is the antidote.

Spread your efforts globally, keep costs low and allow the next generation of market leaders to emerge on time. For retirees and soon-to-be retirees, combine that with a cash wedge to facilitate regular withdrawals and avoid selling stocks in a recession.

This week’s summary:

In the last edition of Weekend Reading I looked at points, areas and spending permits.

Then I reviewed the new and completely updated classic, The rich hairdresser and 81 of you entered to win a free copy of the book by leaving a comment about when you read the original and the impact it had on your life.

Mr Chilton himself said he enjoyed reading all the comments. Wow!

Congratulations to Wendy Ni le, who left a comment on November 5 at 8:09 am. I will contact you today and set up an appointment to send you a free copy of The Wealthy Barber.

Promo of the week:

Do you need a new iPhone or MacBook Air? What about both?

Wealthsimple’s latest promotion could get you one or both, depending on the amount of your deposit and/or transfer.

I know dozens (maybe hundreds) of you have taken advantage of these promotions over the past two years, and while this one doesn’t offer instant cash back, many of you are craving these types of promotions for the simple fact that these devices aren’t cheap.

If you’re looking for a new iPhone 17, it starts at $1,129. And depending on the MacBook, you’ll pay at least $1,299.

• Open a Wealthsimple account (use my referral link here and get an extra $25: http://wealthsimple.com/invite/FWWPDW), and;
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• Transfer or deposit €100,000+ into almost any account within 30 days

Please note that when transferring accounts from one institution to another, keep my Las Vegas analogy in mind:

“What happens in your registered account stays in your registered account. You just move to a cheaper hotel with better amenities. You’re still in Vegas.”

This applies to all registered accounts (RRSP, RRIF, LIRA, LIF, TFSA, RESP, etc.).

Open an account with Wealthsimple, open the appropriate account type(s), initiate the transfer(s), and Wealthsimple’s back office will contact your existing bank’s back office to request the transfer. This is a federally regulated event that takes place every day, and no divorce discussions are required at all.

Weekend reading:

Research shows that investor memories of past performance are distorted. Preet Banerjee explains why that is a problem.

Russell Sawatsky with a great piece on why Index investors continue to behave like stock pickers:

“The upside that investors are looking for has always been there. It doesn’t come from betting on narrow sectors, but from embracing simplicity, discipline and patience.”

More Canadians should consider delaying CPP and OAS until age 70 in exchange for higher guaranteed, lifelong, inflation-protected benefits. But for many retirees, the choice feels too much like a gamble with death. Pension researcher Bonnie-Jeanne MacDonald developed a simple but brilliant solution called a Guarantee for pension deferment. In layman’s terms, if you procrastinate and die prematurely, the guarantee ensures you don’t suffer any losses.

Markus Muhs’ chart of the month looks at the CAPE ratioapproaching its peak during the dot-com bubble, and what investors should do about it:

“The CAPE ratio doesn’t predict crashes; it just reminds us that markets move in cycles. Lower your long-term expectations for market growth, especially for U.S. stocks.”

I really enjoyed this article about the guilt of having money – when financial success feels uncomfortable.

To celebrate book launch day, Dave Chilton invited Preet Banerjee to host The Wealthy Barber podcast and interview Dave. Here’s his origin story:

A Wealth of Common Sense blogger Ben Carlson says The shares are not yet at the level of the dot-com nosebleeds but the last ten years are right in line with Japan and the Roaring Twenties.

Finally, enjoy this visual masterpiece (and excellent article) from Erica Alini on why The era of the shoebox apartment is over and how Canada can build livable apartments to help solve the housing crisis.

Have a nice weekend, everyone!