The typical S&P 500 firm now remains in the index for a shorter period of time

The Ever-Changing Nature of the S&P 500

This article was originally published on TKer.co.

Stock market indices like the S&P 500 are constantly evolving. The companies that make up these benchmarks are frequently replaced as businesses expand, contract, merge, go private, or fail altogether.

According to Ben Snider of Goldman Sachs, “Roughly one-fifth of the S&P 500’s members are swapped out every five years,” as noted in his January 6 research report. The following chart illustrates how this turnover rate has shifted since 1985.

The S&P 500 undergoes significant changes in its composition over time. (Source: Goldman Sachs, via Yahoo Finance)

Why Turnover Matters

This ongoing reshuffling is a key factor in understanding the behavior of the stock market. In fact, it’s highlighted as TKer Stock Market Stock Market Truth No. 9.

At any given moment, a select group of stocks is responsible for driving the market’s gains. However, many of these top performers eventually falter and lag behind. When that happens, new leaders emerge to take their place, helping to sustain the market’s long-term upward trajectory.

As discussed last week, six out of the so-called Magnificent 7 stocks have only joined the S&P 500 within the past quarter-century.

Why Outperforming the Market Is So Challenging 😭

This high level of turnover makes it extremely difficult to determine not just which stocks to own, but also when to own them. Historically, a small fraction of stocks have accounted for the majority of the market’s returns, meaning that most gains are concentrated among a few names. In fact, your odds of picking a stock that beats the market are lower than a coin toss; most stocks actually underperform the index.

Timing is just as important as selection. It’s not enough to know when to buy a market leader; you also need to know when to sell before its performance declines. This challenge is intensifying as the average tenure of companies in the S&P 500 continues to shrink.

Companies are spending less time as members of the S&P 500. (Source: BofA via TKer, Yahoo Finance)

The Passive Investing Approach

Investing in an S&P 500 index fund is considered passive investing because it requires minimal trading on the part of the investor.

However, even passive investors are exposed to a constantly shifting portfolio, as the index regularly adds and removes companies. The positive news is that S&P’s selection process has historically succeeded in including the winners and removing the laggards, which is reflected in the index’s ongoing upward movement.

This article was originally published on TKer.co.