SPY ETF Under Scrutiny: Dividing the Index for Better Representation

The SPDR S&P 500 ETF (SPY) is often perceived as a diversified investment in the US economy, but in reality, a small number of large companies dominate its holdings. A case is made for splitting the index to better reflect the overall market and provide more diversified exposure.

As the SPDR S&P 500 ETF (SPY) remains a popular choice for investors seeking exposure to the U.S. economy, it's essential to examine the composition and diversification of its holdings. While SPY offers broad market exposure, a small number of large companies dominate its portfolio, which may limit diversification benefits. This article explores the argument for splitting the S&P 500 index to better reflect the overall market and provide more diversified exposure.

The S&P 500 index, as represented by SPY, consists of 500 leading companies in major industries of the U.S. economy. However, the top 10 holdings account for approximately 28% of the index's total weight [1]. This concentration can lead to increased exposure to specific sectors or companies, which may not align with an investor's risk profile or market views. For instance, as of 2025, technology and healthcare companies are among the most significant contributors to the index, with Microsoft Corp. (MSFT) and Apple Inc. (AAPL) being two of the largest holdings.

To address this issue, some argue that splitting the S&P 500 index into smaller, more diversified sub-indices could provide investors with a more balanced and diversified portfolio. For example, the S&P 400 MidCap ETF (MDY) and the S&P 600 SmallCap ETF (SCHA) offer exposure to mid-cap and small-cap companies, respectively, which are often overlooked in the broader market. By splitting the index, investors can gain access to a wider range of companies and sectors, potentially reducing concentration risk and enhancing overall diversification.

Moreover, splitting the S&P 500 index could also help address the issue of market capitalization bias. Currently, the index is weighted by market capitalization, which means that larger companies have a more significant impact on the index's performance. Splitting the index into smaller sub-indices could help mitigate this bias by giving smaller companies a more proportionate representation. This approach could lead to a more representative index that better reflects the overall market dynamics.

In conclusion, while the SPDR S&P 500 ETF (SPY) offers broad market exposure, the dominance of a small number of large companies in its holdings may limit diversification benefits. Splitting the S&P 500 index into smaller, more diversified sub-indices could provide investors with a more balanced and diversified portfolio. This approach could help address concentration risk, market capitalization bias, and better reflect the overall market dynamics. However, it is essential to consider the implications of splitting the index, such as potential tracking errors and increased complexity, before making any decisions.

References:
[1] https://money.usnews.com/investing/articles/best-etfs-to-buy