Comparing the S&P 500 Index and MSCI World Index is a smart way to educate yourself on the differences between investing in the U.S. vs all the developed markets. As the story goes, one index is for investors who believe in the continued strength of U.S. equities, while the other is for investors with a more global view. Although the MSCI World shares many of the same holdings as the S&P 500, you should know that the mechanics behind them make the two very different indexes.
For those who might be unfamiliar with the two, here’s a quick recap: The S&P 500 is a stock market index that measures the stock performance of 503 shares from the 500 large companies listed on stock exchanges in the United States.
The MSCI World, on the other hand, is a stock market index that covers around 1,500 stocks from 23 developed regions: the United States, Canada, Western Europe, Israel, Australasia, Hong Kong, Japan, and Singapore. Unlike the similarly popular MSCI ACWI and FTSE All World index, which are “global” or “all world” indexes, the MSCI World does not include emerging or frontier markets.
When deciding between the S&P 500 and the MSCI World, the question most investors ask is whether a multi-country index or a U.S.-only index is a better investment. While time has shown how important it is to have a global portfolio allocation, many strongly believe the U.S. stock market is always the best place to be. The reason for this sentiment is that American stocks have outperformed international stocks for the past decade. It can feel irrational to go against the grain on this one. So, should you let the winner run or prepare for a shift in the tide?
- What they are: The S&P 500 and MSCI World are two of the most widely used stock indexes for passive investing. Around 65% of what’s in the S&P 500 is also in the MSCI World. They’re both bellwethers for the Western world economy and have been performing well over the past decades. You can invest in these indexes through an index, mutual, or exchange-traded fund that owns the underlying stocks.
- The American index: The S&P 500 is the classic U.S.-only index comprising 503 large-cap stocks traded representing all major sectors of the U.S. economy. It’s regarded as a financial barometer to indicate the relative strength or weakness of the larger U.S. economy. The advantage of investing in the S&P 500 is that the U.S. has historically been home to the world’s largest, most liquid, and successful financial markets and the world’s only reserve currency.
- The Developed World index: The MSCI World is the original global stock index that covers 23 countries and consists of around 1,500 large- and mid-cap stocks. Most of what’s in the S&P 500 is also included in the MSCI World, but the concentration is diluted given the incorporation of global stocks. If the U.S. underperforms at some point, the index reshuffles and beefs up other developed countries that are doing better. As such, it’s a nicely balanced mix that avoids the extremes of being focused on a single country and is not so exhaustive that it includes small stocks or emerging markets.
- What you should know: No one country has consistently outperformed in the past. Outperformance has historically always resulted in a subsequent reversal to the mean. However, the modern markets do look different. S&P 500 investors are criticised for not diversifying their portfolios globally and going all-in on the U.S. market. What’s often left out of that criticism is that U.S. companies, mainly the tech sector, generate 40% of their revenue outside the U.S.
- The lazy solution? Investors interested in a neutral allocation might consider an international stock market index fund, which includes U.S., developed market, and emerging market equities in a single investment.
Do you need global diversification?
Let’s start with the central point of the discussion: should you spread out your investments globally, or can you just park your money in a single region? U.S. stocks seem to trounce other markets these years, so why put your money elsewhere? To understand the case for geographical diversification, we need to take a step back and look at how investing in only a single country’s stock market has completely wiped out investors’ wealth in the past.
The most dramatic instances of deep downfalls were caused by extreme political or economic upheaval, such as wars and regime changes – some of which seemed unlikely years before they took place but look obvious when we look back with the benefit of hindsight.
In other cases, countries have endured sustained periods of drought in their financial markets, although their real economy has continued to grow. Japan is the most cited example here. The Nikkei 225 closed at 38,915 at the end of December 1989. Now 33 years later, the index sits at 27,801, almost 29% lower than its all time high. A Japanese investor who started investing at the end of the 80’s could easily have avoided this total meltdown by having a country-neutral asset allocation rather than an overweight of domestic shares.
Of course, those are extreme cases, but they illustrate how dangerous it can be to go all in on a single country’s stock market. When analysing the choice between U.S. and developed world (ex U.S.) stocks, it’s helpful to break down how these markets have performed over the past 40 years. We see that their returns are quite comparable and how the effect of mean reversion in action plays out when given a long enough time frame.
S&P 500 vs. MSCI World: Basics
Let’s look at the structural similarities of the S&P 500 and MSCI World. Both are what are called stock market indexes. A stock index is a statistical way to measure the change in a group of stocks. These stocks, when combined, provide a snapshot of how well or how badly a particular market is doing. When the value of the stocks in the index fall, the value of the index falls. And conversely, when the value of the index constituents rises, so does the index.
In the case of the S&P 500 index, this snapshot shows how some of the largest public companies in the U.S. are faring right now. For the MSCI World, it’s a broader weather gauge of how stocks in 23 different developed economies are doing altogether. We can boil down the fundamental structural difference between the two indexes to this: The S&P 500 measures the U.S. economy, while the MSCI World takes the temperature of the developed world economy.
The index/ETF terminology can be confusing. Indexes are benchmarks created by investment analyst firms like MSCI or Standard & Poor’s. You can’t invest directly in an index; they’re just statistical number crunching. But you can invest in them indirectly through investment funds, like mutual funds or exchange-traded funds (ETFs), that own the stocks making up the index.
The S&P 500 index
The S&P 500 is made up of 503 stocks issued by 500 large-cap companies traded on American stock exchanges, either the NYSE, Nasdaq, or Cboe. The index is widely regarded as the best single gauge of the U.S. stock market. It’s a capitalisation-weighted index, which means the bigger the company, the more influence it has on the index. For example, in 2021, only 9 companies made up almost 30% of the index.
Because the S&P only includes large-sized stocks, many U.S.-focused investors instead opt for indexes that claim to be “total stock market” indexes. These include what’s inside the S&P 500 as well as mid-sized and small-sized companies that are left out of the S&P 500. This way, total stock market indexes attempt to measure the performance of all publicly traded U.S. stocks, not just the big names.
The MSCI World index
The MSCI World comprises around 1,500 stocks listed on exchanges in what MSCI refers to as developed countries. The precise number of stocks and the amount of space they take up in the index changes several times during the year as MSCI periodically rebalances the index. For example, as Meta (Facebook) shares lost value in early 2022, their weighting in the index fell, and other companies moved up to take their place.
The top 10 stocks in the MSCI and S&P 500 are nearly identical because the U.S. is home to most of the world’s largest companies. But the MSCI World goes on to include non-U.S. large-cap stocks in its top 100 holdings since it’s a global index. These include Nestlé (Swiss), Roche (Swiss), AstraZeneca (British), ASML Holding (Dutch), Novo Nordisk (Danish), Toyota (Japanese) and many other recognisable names that play an important role in the global economy.
S&P 500 vs. MSCI World countries
On the surface, the S&P appears only to cover a single country, the U.S., while the MSCI World casts a much wider net with 23 countries. But once we dig a bit deeper, the picture turns a bit more nuanced. Here’s what to keep in mind in terms of geographical diversification.
S&P 500 countries
S&P 500 investors are much more internationally diversified than they may realise. According to Morningstar’s calculations, around 40% of revenues for S&P 500 companies come from outside the U.S. Have you ever visited a country where you couldn’t find a Coca-Cola? Or where the locals didn’t use iPhones? The Coca-Cola Company is based in Atlanta, but that hasn’t stopped it from selling its products all over the world. The story is more or less similar for other companies that deal internationally. Even gas, which until around 2015 wasn’t exported in large quantities from the U.S., is now being piped out worldwide.
Here’s where the risks lie: S&P 500 companies indeed have roots all over the world, but their parent entities are subject to the U.S. “package”, whether that’s U.S. taxation, political risk, social stability or other factors. It’s hard for anyone not to notice the increasing theatre of unrest in the U.S., whether social or economic. So, the question investors need to ask is whether they think the U.S. will continue to provide the best business environment for companies to grow and thrive.
The MSCI World countries
The MSCI World covers equity from the following 23 developed countries: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the U.K. and the U.S. The noticeable absentees are Poland and South Korea, which are included in the similar FTSE World Index but not the MSCI World. China is another, but the country has historically been difficult for foreign investors to access.
Because the MSCI World is made up of so many countries, the standard assumption is that it’s a diversified index. This is true in the sense that the index “doesn’t care” where the money is, as long as it stays within the developed markets. For example, in an imaginary future, if Switzerland and Germany, for unknown reasons, became home to the world’s largest companies by market capitalisation, the index would rotate towards those countries and swap out the underperformers automatically.
When we look under the hood of the index right now, the country weighting of the MSCI World is quite top-heavy. U.S.-domiciled companies account for almost 68% of its total market capitalisation. Among those, a whole 4.5% and 3.7% are in Apple Inc. and Microsoft Corporation, respectively. Japan is second with around 6.17%, followed by the United Kingdom (4.42%), Canada (3.6%), and France (3.11%), while other countries make up 14.04%. Over the last decade, the index weighting of its non-U.S. constituents has declined significantly, the most notable drop coming from the UK, which has been cut in half.
But then again, when we analyse this concentration from the perspective of how an index is supposed to work, it’s clear that the MSCI World’s composition is a result of regular reviews and rebalancing. It’s the result of changing market conditions, which keep an up-to-date picture of the global stock market over time.
S&P 500 vs. MSCI World: Holdings
The top 10 companies of the S&P 500 and the MSCI World are nearly identical in terms of how much they make up the respective indexes. If we extend the comparison, the total overlap between the two indexes sits at around 65%. This means both indexes are heavily tilted towards the same large-cap U.S. companies and that by buying into the MSCI World index, you’re buying 65% of the S&P 500 in the same package.
This only seems to leave a 35% allocation to the rest of the world, which is not very much when considering the MSCI World’s reputation as a diversified index. Still, it does add a layer of diversification that the S&P 500 cannot provide on its own: Since the World index follows a principle of indifference in terms of how it’s spread out across the countries it covers, it’s chasing performance regardless of whether it comes from the U.S., Europe, or any of the other included markets.
S&P 500 holdings
There are 503 companies in the S&P 500. All S&P 500 companies are headquartered in the U.S. The index’s top 10 constituents or stocks are Apple, Microsoft, Amazon, Tesla, Alphabet (Google), Berkshire Hathaway, United Health, Johnson & Johnson, and Nvidia.
MSCI World holdings
There are around 1,500 companies in the MSCI World, although the exact number fluctuates. The top 10 constituents in the index are Apple, Microsoft, Amazon, Alphabet (Google), Tesla, United Health, Johnson & Johnson, Nvidia, Meta (Facebook), and Exxon. The total index holdings are spread across 23 countries.
S&P 500 vs MSCI World: Sectors
Both indexes have a steep tilt towards information technology, followed by healthcare, financials, and consumer discretionary (goods and services).
|Sector||S&P 500||MSCI World|
S&P 500 vs. MSCI World: Overlap
The overlap between the S&P 500 and MSCI World is significant, both in terms of geographical concentration, sectoral spread, and the heavy allocation towards a few megacorporations. 486 of the same stocks are found in both indexes, which means that 96.6% of the 503 stocks issued by S&P 500 companies are also in MSCI World. If we reverse the perspective, around 32.4% of MSCI World’s individual holdings are in the S&P 500. The overlap in weighting of those companies included in both indexes is about 65%.
A pessimistic view of this high degree of overlap would be that you’re not really spreading out your risk much by buying into the MSCI World index as opposed to if you just invested in the S&P 500. The optimistic interpretation is that MSCI World gives you the best of the U.S. package while also heeding the principle of geographic diversification, even if the sector allocation is still top-heavy. You’re more or less getting the same cake but with a sprinkle of international flavour.
S&P 500 vs. MSCI World: Risk
When analysing risk factors and comparing these among two different indexes, there are a few different categories to consider.
We shouldn’t forget that the S&P 500 and MSCI World are human-made constructs. Although based on publicly available methodologies, they are subject to limitations regarding how well they represent the “reality” of the financial markets they wish to reflect. You can review and research further the methodology of S&P’s U.S. indexes and the MSCI’s if you’re interested in exploring this topic in depth.
Between the two, the S&P 500 is subject to more human bias than the MSCI World. Not because it only includes U.S.-based companies but due to its methodology and review process. Unlike indexes like the Russell 3000, which are strictly rule-based (e.g., the weighting of companies in the index is based on their market capitalisation), the S&P 500 includes the intervention of a committee made up of anonymous members. This index committee handpicks the stocks that enter and exit the index among potential candidates. While this human element doesn’t necessarily introduce bias, it does bring a peculiar aspect of arbitrariness to the index.
It’s easy to mistake the S&P 500 for a passive index following the U.S. stock market, but that would be wrong. In fact, it’s quite an exclusive list. There is a secret committee that meets four times a year to deliberate on which companies should be included in, or removed from, the index.
Another thing that’s not widely known is that the S&P 500 represents 500 U.S. large companies but is not necessarily the largest. Also, 500 may have been an adequate number in the 1950s, but it’s not nearly enough to capture the breadth of today’s U.S. economy. There are now more than 4,000 publicly traded companies in the United States.
The MSCI World index is much more systematic in its approach. The index is based on MSCI’s Global Investable Indexes (GIMI) Methodology, which is comprehensive and available for anyone to review. Its rules are clear and objective in terms of what stocks are selected and how they’re weighted. The main point of criticism is the omission of countries that other index providers consider developed markets, such as Poland and South Korea.
Second, we have what we could call non-diversifiable or market risk. This type of risk is inherent to the markets. It cannot be diversified away by investing in a market-tracking index fund. Essentially, it’s the risk that the market as a whole will go up or down. In the current state of play, U.S. equities dominate on the international scene, so the market risk in world and international indexes is heavily intertwined with U.S. market risk. To counter this type of risk, investors can consider non-financial assets like property, or if they want to stay within the realm of stocks and shares, adapt a long time horizon for their investments.
The third point, and here the MSCI World index has a clear advantage because it straddles 23 markets, is country risk. The question of whether one very successful country, the U.S., can continue to single-handedly dominate the performance of the world economy is a legitimate one, and the allure of higher returns over geographical diversification is understandable. The puzzle is that the very same reasons that make U.S. stocks look more attractive (higher returns potential) are also the ones that could lead to their underperformance in the future.
It’s not only about the risk that a particular country’s economy or political situation could deteriorate, thereby affecting the value of companies headquartered in that region. It’s also about the less dramatic probability of something similar to what happened to Japan in the early 1990s – where a country didn’t become unstable or on a trajectory of decline, but its financial markets just stopped growing for a long time.
The viewpoint prevalent among European and other non-U.S. investors is that the U.S. equities-only approach repeats the errors made by many Japanese investors in the 1980s who invested solely in domestic securities. Many investors have a short memory, and it’s easy to forget that the U.S. outperformance in recent years is nothing exceptional that other markets haven’t achieved in the past. For example, from around 2004 to 2012, equities from Europe and emerging markets trounced their U.S. counterparts. While the MSCI World’s performance is being dragged down by the non-U.S. stock sector, the benefit is that if the U.S. market falls, international stocks may hold up better and offer some protection for losses.
S&P 500 vs. MSCI World: History
It’s interesting to take a step back and look at how these two indexes have come about, seeing they’re so hyped among investors.
The foundation of the S&P 500 name is as follows: Henry Poor was a 19th-century financial analyst who compiled an annual book that listed publicly traded railway companies in the United States. After his death, Poor’s publication, “Poor’s Directory of Railroad Officials”, merged with the Standard Statistics Company, which resulted in the creation of Standard & Poor’s Corporation in 1941.
The S&P 500 index, first called the Composite Index, was created on a modest scale in 1923. It began with 90 equities in 1926 and expanded to its famous 500 in 1957. The 500 companies it tracks are large, U.S.-based corporations that trade publicly, meaning their stocks can be bought and sold by the public on stock exchanges. The weighting of stocks in the index is determined by their float-adjusted market capitalisation. What this means is large companies have a more significant impact on the direction of the index than small companies. For example, the top nine companies in the S&P 500 list accounted for 28.1% of overall market value in 2021.
The history behind the MSCI World isn’t nearly as exciting as Henry Poor’s obsessive passion for tracking railroad companies. It started in 1968 when Capital International, an investment management company, licensed its global equity indexes to Morgan Stanley, hence the name Morgan Stanley Capital International (MSCI). The same year, MSCI launched its World Index, intending to track stocks from the developed or industrialised parts of the world. The MSCI Developed Market Index started in 1969, while the Emerging Markets Index was launched in 1987.
S&P 500 vs. MSCI World: Conclusion
Should you add international diversification to your portfolio or bet everything on U.S. stocks? There is no way to know if stock returns in the U.S. will be as high as they have been in the past or if the Americans will pass the baton to another region. The number of unknown unknowns is too great to make any definitive statement either way.
If history is any guide, we should expect future down periods in any given market and assume that winners will rotate between markets, just as they have in the past. Investors who rely on a single region for their equity exposure can find themselves in an unfortunate position where they have to sell at inopportune times to meet their cash needs. Recoveries can take decades or never happen at all, as the Japanese investors who witnessed first-hand in the 1980s.
One of the best ways to balance these unpredictable forces is to build a globally diversified portfolio of developed and emerging market stocks. This will ensure that you always have some geographic region working in your favour and provide some ballast during the down periods for the other markets. With a global index fund or world plus emerging markets combo, you risk sacrificing a few percentage points of return in good times, but you also get the peace of mind that comes with being ready for a potential change in market leadership.
Disclosure: The author held positions in MSCI World and MSCI Emerging Markets ETFs at the time of publication.