Time to dig in a little deeper and go through the structure of financial markets.

Stocks are generally organised into the country they are listed in. For example, British Telecom (BT) is traded on the London Stock Exchange, American Airlines is traded on the New York Stock exchange and Japan Tobacco is traded on the Tokyo stock exchange. The biggest companies are then put together into an Index, which generally tries to represent the size of the company, and arguably it's importance in the economy.

There is usually a number alongside the index name that tells you roughly how many constituents it has in it, e.g. FTSE 100, DAX 30, Nasdaq 100. Therefore once you learn the name of the index, you know which country the stocks are listed in, and how many companies are in the index.

Next up we need to explain how the "weightings" work. The weightings in an index are how it helps represent the size and importance of each company. Lets take the FTSE 100. If the index was comprised of equal weightings, then each of the 100 companies in the index would make up a 1% weighting each.

100 companies*1% = 100% of the index.

This means that if 50 companies stocks went +1% on the day, and 50 stocks went -1% on the day, then the index would be unchanged! Make sure you understand this before moving on!

If that is a bit of a mind puzzle, then lets instead imagining that we are baking a cake. If the recipe has 10 ingredients, then its very unlikely you put in equal amounts of flour, water, butter, milk, eggs, lemon, icing sugar, jam, cream and vanilla extract. Each ingredient has a different weighting in the recipe. If you did, then you might make something that resembles a cake... but it certainly wouldn't be your best performance as a chef!

For the index to truly represent the economy, then you can't have a small UK pension provider and a local DIY retailer have as much effect on the index as the worlds biggest Oil companies and a global bank. To show you how this is solved, I'll take you through the weightings of such companies that are some of the biggest and the smallest in the FTSE 100.

Two of the biggest oil companies in the world, Shell and British Petroleum make up 8.5% and 4.3% of the FTSE. So you can see, the move that the share price of Shell has, is 8.5x more influential now to the index than it was in the equal weighting example above. The global bank HSBC which has customers in different 62 countries has a 6% weighting. So these three companies alone make up nearly 1/5th of the whole index!

At the other end of the weightings scale, one of Britains pension providers, St James Place has only a 0.25% importance on the index. This is almost identical to the Uk and French DIY retailer called Kingfisher (B&Q shops) which has a 0.24% weighting. In fact, over 70 companies of the FTSE 100 have weightings of less than 0.5%.

Now we can say that if BP, Shell and HSBC were all up +1% on the day, then the index has a good chance of being positive no matter what the tiny weightings are doing. This doesn't make them insignifcant, because if you own shares in Kingfisher, then you only care what that stock does. However, if you choose to invest in the index rather than an individual stock, THEN the important take away from this is to understand what you are actually investing in. You are not investing in 100 different companies equally. Rather you are investing a lot into 20 companies, and not very much into the other 80. This is especially true in the United States at the moment.

Let's look at the Index that has 500 of the biggest companies in America in it, the S&P 500 (S&P is the ratings agency Standard & Poors). With 500 components in it, you would expect this to be a fairly broad representation of the biggest economy in the world! Indeed, on equal weightings, each company would only have 0.2% of a weighting each (500*0.2%=100%).

Remember that the breadth an index offers is a simple and effective way of diversification. By this I mean that if one company was found to be defrauding investors in it's accounts, if you owned it's shares then you may lose your whole investment. However even if this company collapsed to zero, the index would only lose 0.2% of it's value. This is one of the main advantages of investing in an index rather than a single stock, to reduce the risk of that single investment going wrong by way of something outside your control.

Unfortunately, the diversification benefit in the United States has been greatly reduced over the last decade. This is due to the dominance by 7 individual companies. Let's look at the weightings of the top 10 stocks in the S&P 500;

1. Apple. 7%
2. Microsoft. 7%
3. Google. 3.75%
4. Amazon. 3.5%
5. Nvidia 3%
6. Meta (Facebook) 2%
7. Tesla 1.75%
8. Berkshire Hathaway. 1.6%
9. JP Morgan 1.2%
10. United Health 1.2%

The total representation of these 10 companies in an index comprising of 500 stocks is an incredible 32%!! So nearly 1/3rd of the index performance is decided solely by the profit expectations of just 0.02% of its constituents. This domination is the most severe it has ever been, and greatly reduces the usefulness of the index diversification. The even bigger problem is that the vast majority of this 32% are tech related companies. While this has been fantastic for the last 14 year tech boom, it is vital that you understand that if you buy a tracker fund of the S&P 500 (or if your pension manager does on your behalf!), then you are investing a third of your money in only 10 stocks.

Despite this issue, the idea of structuring financial markets by indices and countries has been the way it has always worked. Certain popular index's such as S&P 500, FTSE 100 and the DAX 30 are reported everyday in the press, and provide benchmarks for what every investment is judged by over the year!

Our aim by the end of this course, is to put you in a position to beat the benchmark!! The S&P 500 was +24% in 2023. Do you think you can beat that!