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Should my portfolio follow the index?

I keep hearing that an investor’s portfolio of stocks should at least be weighted to represent the weightings of stock in the index. What does this mean and why is it important?

The index that market experts or advisers might be talking about is the S&P/ASX 200 index, which collates the top 200 companies in Australia. They make it based on the number of shares on issue for the public to buy multiplied by the share price and that gives you their market cap or capitalisation. This market cap therefore relates to the size of the company and its relevant importance in the index.

The big companies such as BHP Billiton (materials), CBA (financials), Telstra (telecommunications), etc. can have a big bearing on the index’s performance on a daily basis because they’re so heavy in the weighting of the index.

As of November, the weightings in the index were like this: consumer discretionary 3.68 per cent; consumer staples 9.09 per cent; energy 7.4 per cent; financials 31.58 per cent; healthcare 3.31 per cent; industrials 6.71 per cent; IT 0.61 per cent; materials 25.99 per cent; real estate 6.08 per cent; telecommunications 4.03 per cent; and utilities 1.51 per cent.

Advisers and stockbrokers will look at the weightings of a client’s portfolio and if they are happy to match the index, they will buy shares in the same proportions. If you wanted to outperform the index, you might take a position and, say, buy more materials because you like China and its demand for our resources and less consumer discretionary because you might think David Jones, Myer and the like are up against a weak economy as well as an online threat. Some people buy ETFs based on the S&P/ASX 200 index. These are bought to mirror the index and its weightings.

A good adviser will come up with a set of weightings for a portfolio. As share prices rise and fall, the weightings can get out of whack and that’s why the adviser will re-weight the portfolio.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Published on: Wednesday, January 18, 2012

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