Money Rehab with Nicole Lapin - A Big Stock Index Just Rebalanced - Here's What It Means and Why You Should Care

Episode Date: July 26, 2023

Every week on Wednesdays, Nicole breaks down the biggest headlines on Wall Street and unpacks how they will affect your wallet. Up this week: the Nasdaq 100 just rebalanced. Nicole explains what that means, and how it will impact fellow investors who Index Funds and Chill.

Money rehabbers, you get it. When you're trying to have it all, you end up doing a lot of juggling. You have to balance your work, your friends, and everything in between. So when it comes to your finances, the last thing you need is more juggling. That's where Bank of America steps in. With Bank of America, you can manage your banking, borrowing, and even investing all in one place. Their digital tools bring everything together under one roof, giving you a clear view of your finances whenever you need it. Plus, with Bank of America's wealth of expert guidance available at any time, you can feel confident that your

money is working as hard as you do. So why overcomplicate your money? Keep it simple with Bank of America, your one-stop shop for everything you need today and the goals you're working toward tomorrow. To get started, visit bofa.com slash newprosmedia. That's b-o-f-a dot com slash n-e-w pros p-r-o-s media. bfa.com slash newprosmedia. I'm Nicole Lappin, the only financial expert you don't need a dictionary to understand. It's time for some money rehab. All right, here's your weekly roundup of the biggest headlines on Wall Street and how they affect your wallet. Today's update is all about stocks. The stock market has been on an upswing. It has seriously been on a tear for a while now, with the Dow, the Nasdaq and the S&P 500 indexes all trending upwards since the uncertainty in

March caused by the collapse of several banks. That bounce has come in part from the increasing value of the seven large cap companies whose massive size results in an outsized impact on the market. The market share of those companies has become so large that the Nasdaq 100 underwent some special rebalancing on Monday that would help its index funds adhere to SEC rules about diversification. That was a mouthful. But breaking the story down into little snack-sized pieces is exactly what I'm going to do in this episode. Because if you're like me and your investment strategy involves a lot of index funds and chilling, then this rebalance actually impacts your investments.

Part of the benefit of index funds is that you don't need to track every single move that the market makes, but even so we should still put a little time into understanding how these funds work and where your money is actually going. First, let's meet the players of this story. They are the NASDAQ 100, the companies known as the Magnificent Seven, and index funds like QQQ. So let's take one dictionary note at a time. The Nasdaq 100 is an index that tracks the top 100 large cap nonfinancial companies.

An index is basically a fancy word for a list of stocks. Large cap companies are companies whose market capitalization or market cap is greater than $10 billion, and the market cap is a metric that investors use to talk about a company's value. So these companies in the Nasdaq 100 are companies that investors consider to be super valuable. They are companies you probably know and love and buy from whether you know it or not. Think Netflix, Pepsi, Walgreens. And then adding one more layer, an index is just a list. An index fund is the thing you buy into if you want to invest in all

of the stocks in said fancy list. Enter QQQ. So QQQ is the index fund that you buy to buy the Nasdaq 100. With me? Okay, so we're good on all the dictionary definitions for a beat. The Nasdaq 100 is up an eye-popping 42% year to date as of Monday. To put that into perspective, the S&P 500, another index that tracks the top 500 large cap companies, is only up 18% for the same period. Now they both track basically similar things.

The only difference here is that the Nasdaq is tracking a smaller pool, which explains the big difference in outcomes. Because the Nasdaq 100 is tracking fewer companies, each individual entity has a bigger impact on the final value created by aggregating those numbers. Specifically, the Magnificent Seven are a huge part of the NASDAQ 100's total value. The Magnificent Seven are Apple, Microsoft, Alphabet, which is Google's parent company, the tech company NVIDIA, Tesla, and Meta, Facebook's parent company. These seven make up 50.9% of the index. That would be totally fine if the function

of an index was solely to track how the companies are doing because these companies are having an awesome year. But the major function of indexes, which makes them so valuable to you and me as investors, is that they inform index funds which stocks to buy. So for example, if you buy QQQ, remember that's the fund that tracks the NASDAQ, you're buying shares of a fund that buys shares of companies listed on the NASDAQ. The NASDAQ determines what's in QQQ. So that's who's involved.

The NASDAQ 100, the Magnificent Seven, and index funds that track the NASDAQ like QQQ. So what happened Monday? The Nasdaq 100 had a very special rebalancing on Monday, July 24th. Now, I'm not going to make you sit through the math, but the Nasdaq uses a set formula to determine how much weight each company has in the total index. Every quarter, they just adjust these numbers to make sure that it reflects the current broad market situation. However, under this standard formula, those seven giants became really heavily represented in the Nasdaq 100. So the index decided to rebalance its calculations so that these seven companies would be less powerful. With the way the holdings were currently

distributed and the current value of the companies, funds like QQQ were in danger of violating the SEC's rules about diversification. So the Nasdaq changed its methodology and funds that track it like QQQ followed suit, which in practice meant selling shares of the top companies and buying shares of smaller companies to match new numbers put out by Nasdaq. At the end of the day, the NASDAQ 100 was just about flat, closing the day up 20 points from its close on Friday. The S&P 500, another big index, does not currently need a special rebalance because the top companies on that index do not have the outsized representation that they do on the NASDAQ. But taking a step back at the bigger picture here, the market is up. It's

really up. And it's no longer just the top earners. Gains are spread out across the market. And it's really beginning to feel like a bull market. That trend could easily continue for the next few weeks. However, September has historically been the worst month for the market. Now, that doesn't mean it will be the worst month this year. It just has been. That's a data point. But if you're index funds and chilling, then these market fluctuations are nothing to you because you have your eye on the long game, not the month-to-month returns. In other behind-the-scenes news that will impact your bottom line, the federal government is overhauling a system it uses to facilitate

the transfer of money between banks with the launch of the new FedNow program. Does anyone else think they should have workshopped that name a little bit more? Anyway, name aside, the FedNow program is financial software that allows banks and individuals to send money instantly. Basically, it's Venmo at the institutional level. Right now, a number of banks and payment processing servers are signed up to participate in the soft launch of the program. The FedNow program isn't designed to replace apps like Venmo or services like PayPal. Rather, it will complement them. It's mostly expected to be used initially by large institutions like

banks and financial services companies. While it's great for us, the user, to be able to transfer money instantly, banks don't love this as it could raise the risk of bank runs. Just like Venmo allows you to send cash to your friends for brunch. Just like Venmo allows you to send cash to your friends for brunch, the FedNow program allows banks to send cash to each other for bonds. This program is about electronic payments, not about creating a digital currency, I should note. It does, though, mean that you can send money from your bank account on nights and weekends, just like you can with Venmo, instead of waiting for business hours the way you had to under the

old system of transfers. For today's tip, you can take straight to the bank. Today we talked a lot about the relationship between index funds and the indexes they track. Take this as an opportunity to do a little of your own rebalancing. Sit down and track how much you're bringing in after taxes versus how much you're spending. Is there an area where you can rebalance your budget a little to invest a little more, let's say, or pull back a little more in other areas, looking at your own hard numbers and doing a little rebalancing of your own can always be helpful. Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin. Money Rehab's executive producer is Morgan Lavoie.

Our researcher is Emily Holmes. Do you need some money rehab? And let's be honest, we all do. So email us your money questions, moneyrehab at moneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at Money News and TikTok at Money News Network for exclusive video content. And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.