To add US stock exposure to our portfolio, everyone recommends S&P 500 Index.
But Nasdaq 100 has grown at an average rate of 20% per year for the last 10 yrs.
S&P 500 has given a return of 13.5% during the same period.
But still everyone discourages to get Nasdaq 100 exposure, claiming that it is a sector based fund.
And so it has more risks.
Does it actually have that much risk?
Lets see how different is Nasdaq 100 from S&P 500 in this episode.
Hello Everyone! My name is Vijay Mohan. You are watching "Investment Insights".
Lets check out the differences between S&P 500 and Nasdaq 100 one by one.
S&P 500 - We can understand just from the name that it has top 500 companies in USA.
Nasdaq 100 - This has top 100 Non-Financial companies in USA.
that is, other than financial companies, other top 100 companies are in this index.
Next difference is Market Sector.
In S&P 500, it has exposure to each market sector depending on its size.
The one with highest exposure is "Information Technology" - 28%.
In India, when it comes to Information Technology sector, we see consulting services based companies like Infosys, HCL etc.
But in US, we see product and software based companies like Apple and Microsoft.
In that regard, the information technology sector in USA is not that focused as we think.
It is diversified within that sector.
Then Health Care - 13%.
Companies that make/research medicines, Medical Equipments, and companies that provide health insurance - all come under this health care sector.
Consumer Discretionary is 13%.
Consumer discretionary has companies that are related to non-essential products.
Amazon, Starbucks, Tesla come under this category.
Communication Services - 11%.
Dont assume that just mobile phone companies come under Communication services. Google, Facebook, Netflix come under this category as well.
Financials - 11%.
Companies like JP Morgan Chase, Bank of America, GoldmanSachs come under this category.
All these are the bigger sectors in S&P 500.
Other than these, small sectors like Industrials, Consumer Staples, Utilities, Materials, Energy, Real Estate are also there.
OK, what do you think is the market sector that is in Nasdaq 100?
If you say that 100% is Information Technology - Wrong.
It is just 49%.
When compared to S&P 500, it has 21% more in Information Technology.
The second biggest sector here is Consumer Discretionary. It is 19%.
Then Communication Services 19%.
Just these 3 sectors add up to 87%.
Of the rest 13%, half is Health care and the rest is consumer staples, Industrials and Utilities.
There are few things to note here.
1. Nasdaq 100 is not just Information Technology as we think.
More than half of it has other sectors as well.
2. Nasdaq 100 does not have sector diversification as good as S&P 500.
Information Technology, Consumer Discretionary and Communication Services are its core focus.
These 3 sectors make up 51% in S&P 500, where as in Nasdaq 100 it is 87%.
3. Financial sector is totally missing from Nasdaq 100.
Index definition itself has said that it is Non-Financial. We cannot expect that here.
Lets take a look at the top holdings.
Apple, Microsoft, Amazon, Facebook, Google and Tesla are the top holdings in S&P 500.
These alone make up close to 24% of the index.
Nasdaq 100 has the same 6 as top holdings. But it has twice the amount than S&P 500.
These 6 companies make up 44% of Nasdaq 100.
We can see this with two different perspectives. "These are all well grown companies.
"The chances of them growing further is very less.
"So the lesser exposure to these companies in S&P 500 is better."
Or the other perspective is "we can see these as winning horses.
"Revenue growth of these companies have not slowed down till now.
"We should definitely have more exposure to these companies. So Nasdaq 100 is better. "
Lets check out the difference in performance.
In this chart, blue line is Nasdaq 100. Green line is S&P 500.
We can see that Nasdaq 100 ripped high from 1999 to 2000 and then after dot com burst, it came down to S&P 500 level.
From 2001 to financial crisis in 2008, both do not have that much difference in performance.
But during the recovery of financial crisis, smart phone market started exploding.
Along with that, FAANG stocks - Facebook, Amazon, Apple, Netflix and Google also started expanding aggressively.
Microsoft as well.
All these are Nasdaq 100's core holdings.
That resulted in last decade as the best run for Nasdaq 100.
On average it has given 20% return every year.
S&P 500 has given 13.5% return during the same period.
When we look at the chart, the current situation looks like the dot bubble during 2000 right?
Is it possible for the current performance to continue like this?
To understand that, we need to see how its top holdings going to perform in the future.
Apple's revenue will keep rise as long as there is craze for iphone and ipad.
Microsoft - as long as its cloud business is going to expand, it is not going to slow down.
Amazon - it does need any explanation. Revenue has been continuously climbing up vertically.
Google - are we going to stop using google any time soon?
People who are using google is keep expanding every year.
Advertising revenue is going to keep rising as well.
Same story in facebook as well.
When all its top holdings is growing up like one with steroids, Nasdaq 100 will keep rising as well.
The big difference between now and the dot com period then is "Valuation".
At that time, Nasdaq'a average P/E ratio was over 200.
Now it is close to 40.
I am not saying that the valuation is not expensive. I am just saying that the valuation is not that crazy as it was during dot com period.
The valuation now definitely has fundamentals backing up.
S&P 500's P/E ratio itself is now close to 45.
Compared to that Nasdaq'a P/E ratio 40 seems better.
What about the risks in Nasdaq 100?
As we already saw, S&P 500 is well diversified.
Though Nasdaq 100 is a broad index, it is a narrow one when compared to S&P 500.
So Nasdaq 100 definitely has more risk than S&P 500.
There is no doubt. But the growth that we get from Nasdaq 100 can justify the extra risk for some.
It is your personal choice.
Also S&P 500 has 500 companies.
Nasdaq 100 has just 100 companies.
It is narrow in that regard as well.
So Nasdaq 100 has less diversification when it comes to size as well.
But we can also say that as it has more concentration.
When the concentration is higher, the growth will be higher as well.
What they say in investment circle is, if you want wealth growth, then focus on concentrated portfolio.
But if you care more for wealth protection, then go for diversified portfolio.
It is up to you to decide if you want wealth growth or wealth protection.
Usually people with a smaller portfolio size focus on Wealth growth.
When the portfolio size grows bigger, they switch to wealth protection.
Also there is myth that Nasdaq 100 is more volatile.
But we can see from this chart that its volatility is comparable to S&P 500.
In recent times it is bit higher. But it sis a good thing. Because the volatility is higher, return is also higher when compared to S&P 500.
So the final summary is, whoever wants a full diversified exposure to US market can invest in S&P 500.
US folks can go one step further and invest in Vanguard Total Stock Market Index - VTI.
But if you like the focused approach in Nasdaq 100 and also if you strongly believe in Technology growth,
and also if you understand that extra risk, then you can invest in Nasdaq 100.
Or you can keep this simple by investing half in S&P 500 and the other half in Nasdaq 100 knowing that both these are going to go up in the long run anyways.
Please let me know what kind of content you are expecting in this channel in the comments below.
I will try to create future episodes based on that. We will soon meet again in another episode. Thank You.