[keernan]

There is nothing wrong with your desire to 'dump[ing] a lot of money into one company'. That is easy to do without an index fund. And it is not the investing theory behind the creation of index funds and their investing purpose. When 8 companies dominate an index fund, that means the index is not performing the intended function for which it was created.

[dangus]

But the index fund is doing what it was designed for, which is to index on the companies based on their relative importance in the marketplace.

And that’s really my whole point. Someone who is buying an S&P Index fund wants to own more Apple than GoDaddy, because Apple represents much more economic activity than GoDaddy.

[keernan]

I have read John Bogle extensively. I believe he would disagree with you about the purpose behind why Bogle invented the index fund. Index funds are cap based primarily because that saves on costs (there is no need to rebalance the index). But the philosophical framework is diversification. When 10 companies make the other 490 irrelevant in producing the annual return of the index, the index itself is no longer serving the diversification purpose.

Nobody is going to deny enjoying the monetary gains produced by the index becoming concentrated. But it comes at the cost of the portfolio risk that diversification (i.e. absence of concentration) is intended to eliminate.

[dangus]

I totally get what you’re saying.

I’ll make an analogy to maybe help explain what I mean further:

I own a somewhat diverse set of 50 company stocks, at least for the purposes of this exercise.

Let’s say a bunch of those companies merge, now there’s only 20 companies.

No product lines have been discontinued. The companies make all the same things with the same client lists.

Did my investments become less diverse when these companies merged? Perhaps in some ways yes, in many other ways no.

Is my investment portfolio more diverse if I own one stock, Apple, or if I own three stocks, Time Warner, Paramount, and Comcast? All these companies make media content, but Apple is in more industry verticals overall in addition to being a media company (or at least, we can say they are for the purposes of this analogy). If the content industry collapses, Apple is fine, the rest not so much.

[keernan]

Size and success is not a diversification factor. Investment history is scattered with the bones of 'golden child' companies that never saw the death train coming at them through the tunnel. Intel. Nokia. Blockbuster. Yahoo.

Moreover, your examples are crossing over into active investing versus indexing. Indexing theory submits active investors cannot beat indexing over time (Buffet's purchasing/controlling whole companies notwithstanding).

[dangus]

I'm not talking about size and success, I'm talking about participation in a diverse array of industry verticals.

My example is not meant to specifically talk about active investing, I'm just picking out companies to discuss within a hypothetical index holding.

> Intel. Nokia. Blockbuster. Yahoo.

Interesting, 3/4 of these still exist and are doing reasonably well. If you bought their stocks 30 years ago you'd be up on your investment on all of them except for Blockbuster. Obviously, they're not top performers in that timespan (although Nokia ADR pays dividends like other telecoms so maybe it is a good investment in the right index).

You have inadvertently demonstrated some of my point here: companies that serve diverse verticals stick around for decades. For example, Nokia’s consumer business evaporated but their telecom business is still here. See also: BlackBerry.

[cj]

I wonder what a solution could look like. Perhaps keep the market cap weighting, but cap the weighting at a max $500b (or some sliding scale to prevent the top X stocks from composing more than Y% of the portfolio)

[keernan]

That would certainly be a way to control escalating concentration but at the expense of keeping index fund costs low. The Vanguard Total Stock Index (VTI) has an expense ratio of 0.03 - almost zero. Low expenses is a critical factor behind why index funds outperform active investing. So, yes, your proposal would work, but the expense ratio would up to implement the cap.