So, most investing advice is to diversify across the market by choosing to hold assets with different market caps.
What got me thinking is my mid-cap index fund (VEXAX) happens to hold Tesla right now, which is a hot company. What happens if an up-and-coming company like Tesla grows in market cap much larger than what my midcap index would usually invest in? How does this affect the my fund's performance?
Basically, they sell it. So they "sold high" - and they would "sell low" any stock that dropped below the criteria for the fund.
So when I buy a mid-cap fund, I'm essentially making the bet that mid-cap sized companies are going to do well, for some reason. I am NOT making the bet that the currently existing midcap companies (such as Tesla) are going to do well and that I will ride that train to to top. If many mid-size companies do well and outgrow the index, it "sells high" often and the index increases. If many mid-size companies start to fail and drop out, the index sells low a lot and falls.
By diversifying across the dimension of "market cap" what are we really doing? Why would we expect larger companies to do better on average than small ones? (This would lead us to choose to hold more large-cap) or vice-versa?
Or, is it not about growth at all and we simply find that differentiating by market cap has historically been a good way to adjust volatility relative to expected return?
TLDR market cap weighting seems arbitrary, so why is this the preferred method over, say, sector investing (also popular) or splitting over some other dimension?
Submitted April 14, 2017 at 12:21AM by Sprizzlez http://ift.tt/2p2lcKQ
