Ahmedabad Investment：Nasdaq 100 versus S&P 500： Which Index Is Better For Investing In The US？

If you are looking to invest in US equity markets through the mutual fund’s route, you will typically see that most funds benchmark their performance either against Nasdaq 100 or S&P 500 indices. Even the passive funds offered by Indian mutual funds are the ones tracking either of the two indices. This is probably because Nasdaq 100 and S&P 500 are among the US equity markets’ oldest and widely followed benchmarks.

Nasdaq 100 and S&P 500 are both popular large-cap heavy indices, and you will find some similar names in their top holdings, but at the same time, they are pretty different from each other in terms of the number of companies they track, their weights as well as sector allocation. This has resulted in a difference in the performance of the two indices over various periods. Therefore, if you are looking to invest in any of the funds tracking these indices, it will be helpful to understand the construct of these indices.

In this blog, we will explain what you get if you choose to invest in funds tracking either Nasdaq 100 or S&P 500 indices and how they differ in performance and portfolio. This will help you select the fund that suits your risk and return profile.

Launched in 1957, S&P 500 is one of the oldest indices of the US. The index is made up of stocks of the 500 biggest listed US companies. These companies combined represent more than 80% of the total market capitalization (total shares of a company multiplied by the number of shares) of the companies listed on the US stock exchange. Therefore, S&P 500 index can be considered a broad indicator of the US equity markets.

The weightage of companies that are part of the index is based on their market capitalizations. The higher the market cap, the higher the weightage of the stock in the index. The market cap of the stocks is calculated by multiplying the number of shares available for trade on the stock exchange by the company’s stock price. Apart from market cap, there are other criteria for stocks selection such as percentage of shares available for public trading, earnings growth, trading volumes (share price multiplied by the number of shares traded), etc. It is also ensured that sector balance is in line with the overall market cap of the listed companies on the exchange so that no sector has a disproportionately high weight in the index.Ahmedabad Investment

Although the top holdings include tech biggies such as Apple and Microsoft, the allocation to the sector combined is less than 30%. Companies from the top three sectors together account for around 53% of the index portfolio, which is far lower when compared to Nasdaq 100.

Following are the top 10 holdings of the S&P 500 index, which have the highest market cap among all the stocks of the S&P 500.

With around 500 stocks, the index represents over 11 sectors, including information technology, energy, materials, industrials, consumer discretionary, consumer staples, health care, financials, communication services, real estate, and utilities. A large number of 500 stocks in the index ensures that the portfolio is not tilted heavily towards any particular sector or stock.

The following table shows the top sectors represented in the S&P 500 index.

Launched in 1985, Nasdaq 100 index represents the biggest 100 non-financial companies listed on the Nasdaq Stock Exchange.

The US is home to some of the biggest financial and technology companies. The exclusion of the financial biggies results in Nasdaq 100 being dominated by global tech majors including Apple, Google, Microsoft, Tesla, etcVaranasi Investment. These companies are the world leaders in the technology and innovations sectors. Nasdaq 100 also includes the popular FAANG (Facebook, Apple, Amazon, Netflix, Google, or Alphabet) stocks of the biggest tech companies across the globe. Tech companies combined account for over half of the holdings of the index. The dominance of the technology stocks in the index makes it a narrower tech-heavy index.

Nasdaq 100 index is generally recognized as a tech index, but it also includes Pepsi and Starbucks; however, the allocation is not very high.

The following table shows the top sectors of the index.

Nasdaq 100 has significantly outperformed S&P 500 in terms of performance. Over the past 15 years, Nasdaq 100 has delivered a CAGR of around 16%, while S&P 500 has returned about 8%.

The following graph shows that if you had invested in either S&P 500 or Nasdaq 100 at the beginning of any month in the last 15 years and held the investments for 10 years, this is how your returns might have looked like. Nasdaq 100 has outperformed S&P by a wide margin.

The average 10-year return of Nasdaq 100 over these 15 years was around 9%, while that of S&P 500 was about 5%. You could have earned a maximum 10-year CAGR return of 21% by investing in Nasdaq 100, while in the case of S&P 500, you could have earned a maximum return of 14% in the past 15 years.

The returns of Nasdaq 100 are nothing short of impressive but the fact that most of these returns were derived from a few stocks may not be appreciated by many investors especially those who want better downside protection. As the portfolio of Nasdaq 100 is concentrated words technology stocks including FAANG stocks, the performance of the index is mainly driven by these stocks. If the technology sector goes through turmoil, Nasdaq 100 is likely to hit harder, as seen in the past. During the dot-com bubble burst in 2002, Nasdaq 100 corrected around 38%, while the fall in S&P 500 was limited to 23%.

Therefore, the volatility in the returns of Nasdaq 100 is likely to be higher when compared to S&P 500. Even in the 2008 correction, the fall in Nasdaq 100 index was 42%, while the S&P 500 was limited to 38%.

FAANG stocks account for around 30% of holdings of the Nasdaq 100 index while the allocation to the same in S&P 500 is around 14%. The FAANG stocks had a great run over the past five years. The renewed focus towards technology post the pandemic has supported the earnings growth in the technology companies. These stocks have been disruptors as they have changed the way people shop, work, and entertain themselves. Good earnings growth and a bright outlook ensured the past five years were among the best years for technology stocks in the past decade. The following table shows the CAGR returns of the FAANG stocks over the past 5 years. The CAGR returns have been in the range of 23-40%.

The significantly higher allocation towards FAANG stocks has ensured that Nasdaq 100 has outperformed S&P 500 index by a wide marginAgra Investment. The following graph shows the contribution of FAANG stocks to Nasdaq 100’s performance assuming the allocation had remained at the current level of 30% in the past.

The numbers clearly show that the Nasdaq 100 has significantly outperformed S&P 500 index in terms of return over long term despite witnessing higher correction. However, a tilt towards technology stocks makes Nasdaq 100 look more like a thematic index. As the FAANG stocks, which account for a majority of the portfolio of Nasdaq 100, have already rallied quite a bit, they may find it difficult to sustain such as run going forward and if there is a correction in the markets, they are likely to get hit harder as seen in the past.New Delhi Wealth Management

Therefore, the downside risk is likely to be higher in case of the Nasdaq 100 when compared S&P 500 index, which has a much broader representation of the US companies across different sectors.

So, if you are looking to own a more diversified basket of stocks, the S&P 500 will be the right fit for you. However, those who are comfortable with the slightly higher risk for the extra returns that investing in Nasdaq 100 based fund might generate will be better off with Nasdaq 100.

Choose the index based on your own risk and return profile.

Varanasi Investment