Hello, YieldAlley readers! In this issue:

🏠 HELOC rates are at their lowest level since 2023. (CBS)

🚗 Tesla says shareholders approve Musk’s $1 trillion pay plan (CNBC)

☕️ The insanity over the Starbucks “Bearista” cups tells you everything you need to know about the US economy and markets (Sherwood)

🏝️ More Middle-Income Americans Are Trying to Make a New Life Overseas (WSJ)

🏅 Why Vanguard Small-Cap ETF Is One of the Best (Vanguard)

The numbers are seductive. Over the past five years, the Magnificent 7—Apple, Microsoft, Alphabet, Amazon, Meta, NVIDIA, and Tesla—delivered 94% cumulative returns while the broader S&P 500 managed just that same figure with 500 companies doing the heavy lifting. Last year alone, a Magnificent 7-focused ETF returned 38% versus the S&P 500's 17%.

For investors watching these numbers, the logical question becomes irresistible: Why own anything else?

The answer depends on what you've learned from market history—and whether you're willing to bet you know something the market consensus doesn't.

The concentrated approach appeals to several legitimate investor profiles.

Momentum investors sees dominant market leaders with expanding competitive moats, massive free cash flow, and central positioning in high-growth sectors like AI, cloud computing, and digital advertising. These companies are at the forefront of architecting the future infrastructure of the global economy. From this perspective, allocating heavily to proven winners makes intuitive sense.

Growth oriented investors acknowledge that while NVIDIA trades at elevated multiples and Tesla's valuation seems untethered from traditional metrics, these companies have demonstrated the ability to grow into their prices. If you believe artificial intelligence represents a genuine inflection point comparable to the industrial revolution or the internet's emergence, concentration in the companies building the foundation seems rational.

And some investors argue that even if you believe in diversification as a principle, the S&P 500 is already over-diversified with the Magnificent 7 representing 35% of market cap. Why dilute a high-conviction thesis with hundreds of mediocre companies? Why own a struggling regional bank or a stagnant industrial conglomerate when you could own seven proven cash-generating machines?

The math supporting this case is real. Over the past decade, the Magnificent 7 explained virtually all stock market gains. The remaining 493 companies in the S&P 500 essentially treaded water. Owning a concentrated portfolio of these seven would have crushed the index through sheer weight of outperformance.

But here's what makes this decision genuinely difficult: you simply can't predict which companies will stay dominant. And history shows this happens over and over again.

Consider this sobering historical fact: 25 years ago, the top 10 S&P 500 companies were Exxon, General Electric, Cisco, Pfizer, Walmart, Microsoft, Citigroup, Merck, Intel, and AIG. Of those ten, only Microsoft remains in today's top 20. Exxon is the only other name still near the top, while GE, Cisco, Intel, Citigroup, and AIG experienced devastating declines.

These were companies that seemed as dominant then as the Magnificent 7 seem now. Cisco was briefly the world's most valuable company. GE was the gold standard of American industrial power. Intel owned semiconductor manufacturing. Yet many became cautionary tales.

The very act of investing heavily in today's proven winners increases your probability of owning tomorrow's disappointments. Research from Hendrik Bessembinder, a finance professor who studied stock returns from 1926 to 2020, found that four percent of all listed companies were responsible for 100% of the stock market's net gains. The other 96% collectively matched Treasury bills. This suggests two critical insights: (1) the winners matter enormously, and (2) you will not know which companies are winners until after the fact.

The Magnificent 7 today might be that winning 4%. Or two of them might be Amazon and the other five might be the next Cisco. You cannot know in advance.

Concentration amplifies human behavioral errors at precisely the moments they matter most.

When your concentrated portfolio drops 30% in a market correction (and it will eventually), the psychological pressure to abandon the strategy at exactly the wrong moment becomes nearly irresistible. An investor holding the S&P 500 experiences a 30% decline as a market-wide event — that’s unfortunate but shared. An investor holding seven concentrated stocks experiences it as validation that they made a catastrophic bet on the wrong companies.

This psychological difference has real consequences. Studies consistently show that concentrated portfolios tend to generate worse outcomes than the underlying holdings justify because investors abandon them at market bottoms.

In addition, there is also a subtle tax and rebalancing cost to heavily concentrated portfolios. With seven holdings, if one stock represents 20% of your portfolio and it drops 50%, your allocation becomes dangerously off-balance. Rebalancing forces you to sell winners and buy laggards, creating tax friction and fighting against momentum precisely when momentum still favors the concentrated holdings.

The S&P 500 case isn't that it's "good enough" or represents some philosophical virtue of diversification. It's more pragmatic: the S&P 500 automatically solves the problem you cannot solve yourself, which is identifying future winners.

When Broadcom surged into the elite tier recently, investors holding the S&P 500 automatically got exposure without needing to predict its ascent. When Netflix dropped out of the Magnificent 7, the index adjusted without forced selling. When the next revolution emerges, the S&P 500 automatically captures it.

The S&P 500 approach also benefits from mean reversion in sector leadership. When technology becomes this concentrated, capital tends to flow elsewhere seeking better valuations. Over the past century, the sectors driving market returns have rotated between technology, energy, healthcare, financials, and industrials. No sector has remained dominant indefinitely. Owning the full index captures whatever sector emerges as the next driver of returns.

Interestingly, the actual data suggests a compromise exists that most investors don't consider: owning the S&P 500 as your core but supplementing with small positions (5-10% of equities) in specific Magnificent 7 stocks you believe in most strongly.

This captures most benefits of diversification while acknowledging that these seven companies deserve overweight positioning relative to the broad market. You get automatic rebalancing toward the index while maintaining the ability to express conviction in specific holdings. It's not pure indexing, but it's also not the single bet of concentrated ownership.

Ultimately, both approaches involve accepting uncertainty you cannot eliminate. The Magnificent 7 investor accepts the risk that today's dominance ends the way GE's and Intel's did. The S&P 500 investor accepts the opportunity cost of not being fully allocated to the clear winners.

What matters isn't choosing the "right" strategy in hindsight. It's choosing one you can actually stay committed to through market cycles, poor performance periods, and the inevitable moments when your choice looks catastrophically wrong.

History suggests that concentration works brilliantly until it doesn't, and diversification feels like a drag on returns until suddenly it saves your portfolio. The only edge you have is knowing which psychological experience you can actually tolerate living through.

Government Money Market Funds (7-Day Yields)

Brokered CD Rates (6-Month Rate)

ETFs (30-Day Yields)

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