On July 24th a special rebalance was held to reduce the Nasdaq 100 Index’s concentration in its largest holdings. 

This is the third such special rebalancing (1998, 2011) as part of the methodology that states: 

“A special rebalance may be conducted at any time based on the weighting restrictions described in the index rebalance procedure if it is determined to be necessary to maintain the integrity of the Index”.

Some questions to consider: 

• What is the potential impact to you as an index investor? 

• Do you practice a similar rebalance process for individual holdings and asset classes?

How did we get here?

The performance of a small group of mega-cap stocks drove returns for the index and the broader market. These stocks include:

• Microsoft (Year-to-date return as of 7/17/23 is 38.9%) 

• Apple (45.5%)

• NVIDIA (188.7%)

• Amazon (51.4%)

• Tesla (118.9%)

• Meta Platforms (144.4%)

• Alphabet Class A (32.0%) and Class C (31.7%).

These seven companies (combining Alphabet’s share classes) represented over 55% weighting of the index and will reduce to 38% with smaller companies within the index being purchased.

Potential impact to index investors.

Selling high-performing stocks comes with the potential for a tax bill for funds. 

Per Morningstar, “Mutual funds may be especially susceptible to capital gains distributions. An ETF like QQQ is among the most heavily traded securities in the United States, which results in plenty of opportunities for it to utilize in-kind creations and redemptions to purge low tax-basis securities, making capital gains distributions unlikely.”

The importance of rebalancing. 

A challenge investors have with rebalancing is selling or trimming winners and reallocating proceeds to other areas of a portfolio, including underperformers. 

Some envision these 7 companies to continue their dominance, but consider Top 5 Nasdaq-100 holdings in 1998: Microsoft, Cisco Systems, Intel, Dell and Worldcom, yes that Worldcom. By 2008, only Microsoft was still in Top 5 and it had a total 10-year return of -33%. Again, negative 33%. 

In ten years the leadership will look different, so will returns.  

Rebalancing asset classes within diversified portfolios. 

Given S&P 500 Index 15 year outperformance over other asset classes and recency bias toward 4% money markets, many avoid rebalancing or other asset classes entirely like bonds, small company stocks, international stocks, REITs, commodities, gold, etc.

Again, the next 10 years will not look like the past 10 years.  

For example, on January 1, 2000 a diversified portfolio of index funds may have included S&P 500 Index, US Bonds (Barclays US Aggregate Bond Index), International Stocks (MSCI EAFE Index) and Gold. 

By start of 2010, total returns were Gold 274%, US Bonds 84%, International Stocks 12% and S&P 500 Index -9%, aka “The Lost Decade”. 

Go out to January 1, 2017, US Bonds 137% are still outperforming S&P 500 Index 112%. 

Some would argue it made sense not to rebalance, until see a rebalance to “out of favor” S&P 500 Index to start 2010 would lead 7 years later US Bonds 30% and S&P 500 133%. As for top performer during 2000’s Gold, it was the worst at 5%. 

There’s more to consider that allowed in this space, consider reaching out to your Certified Financial Planner to discuss further. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Glenn Brown is a Holliston resident and owner of PlanDynamic, LLC, www.PlanDynamic.com. Glenn is a fee-only Certified Financial Planner™ helping motivated people take control of their planning and investing, so they can balance kids, aging parents and financial independence.

Sponsored articles are submitted by our advertisers. The advertiser is solely responsible for the content of this article.