Does Investing in an S&P ETF Equal Diversification?

An S&P ETF is a bundled investment opportunity tracking the values of large-cap common stocks offered in the United States. Since the S&P is only focused on these types of stocks, it does not account for commodities, currencies and small-cap products. So, if you were to purchase an ETF using only S&P products, you would have some diversification, but your portfolio would not necessarily be diversified.

ETF Diversification

An exchange-traded fund is not necessarily diversified, but it is more diversified than one investment product alone. The fund is composed of many parts. The fund is valued at the sum of these parts as they trade on a daily basis. Some ETFs are designed to give broad exposure to a given market, like the bond market. Some ETFs, though, are designed to narrow down on a specific field like an ETF tracking the value of Yen. An S&P ETF would be focusing only on those stocks listed by the S&P, which, as previously mentioned, only lists large-cap US stocks, meaning the issuers have over $5 billion in capitalization.

S&P Diversification

The S&P is not that diversified in its intention. It was created as an index to track only one type of product on a daily, monthly or yearly basis. Just as the Dow Jones Industrial Average focuses on only 30 large companies, the S&P 500 focuses on only 500 large companies. Therefore, selecting an S&P ETF would result in stocks from a number of companies in different industries, but all of those companies would be large organizations.

Typical S&P ETF

Most investors will consult with a professional regarding purchasing an S&P ETF. The professional trading group, such as an investment bank, would be the one to package the ETF and ready it for trade. The customer would have to ask specifically if the investment house has an S&P ETF. When an investment adviser speaks about an S&P ETF, though, the adviser may be referring to an ETF listed or recommended by the S&P. In this case, the situation would be very different. The S&P does issue lists of ETFs it recommends. S&Ps' newsletters often offer tables showing how a portfolio could be diversified by owning a combination of ETFs across platforms. For example, the S&P could recommend allocating 35% of a portfolio to a large-cap blend, 6% to a mid-cap blend and 4% to a small cap blend. This was an actual recommendation issued by the S&P in the past. 

Alternatives for Diversification

If an investor is truly looking to diversify, she should consider purchasing ETFs across multiple different platforms. This would include some recommended S&P ETFs as well as bond ETFs and bank ETFs. These other products will counterbalance the risk each carries, attempting to create a less volatile portfolio. Looking to the S&P alone for investment advice or listings will create a narrower portfolio even if an investor is focusing solely on ETFs, which are by nature slightly more diversified than individual stocks and bonds.

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