When one very large company has a bad day, an index fund that holds it has a slightly worse day too. How much worse depends on one number: the share of the fund that company represents.
Thursday, Nov. 12, offered an example. Nvidia shares fell nearly 12 percent during the session after the company announced that Chief Executive Jensen Huang had resigned, then closed down 4.3 percent, Reuters reported. The S&P 500 closed down 0.35 percent.
The rule: weight by size
Most broad stock index funds are capitalization-weighted. Each company is held in proportion to its market value, the total worth of its shares. A larger company takes up a larger slice of the fund. A smaller one takes up a smaller slice.
The rule has a direct consequence. When a holding falls, it pulls the fund down by roughly its decline multiplied by its weight. A company that is a large slice of the fund moves the fund more than a small company falling by the same percentage.
The same arithmetic works in the other direction. A large holding that rises lifts the fund in proportion to its weight.
Many holdings, one result
A broad fund owns many companies, and on most days they do not all move together. Thursday showed that too. While Nvidia fell, Advanced Micro Devices rose 5.9 percent and Broadcom 5.5 percent, according to Reuters. Energy stocks in the S&P 500 gained 1.5 percent, the best of the 11 sectors, Reuters reported.
A fund that tracks an index holding all of those companies adds every one of those moves together, each multiplied by its own weight. The fund's result for the day is the sum. That is why a 4.3 percent drop in one stock and a 0.35 percent drop in a broad index can appear on the same day.
The container and what is inside it
A 401(k) or an IRA is a container. It holds investments; it is not an investment itself. Index funds of this kind are common options inside 401(k) plans.
When a saver opens a statement and sees the balance lower after a day like Thursday, the account did not lose value on its own. The funds inside it did. The rules of the container, such as how much may go in each year and when money may come out, do not change because a stock fell.
It also helps to keep two numbers apart. A contribution is money a saver puts in. A return is what the investments do with it afterward. A single day's drop affects the second, not the first.
What a saver can check
The fund's own documents list its largest holdings and their weights. Those weights show how much any one company can move the fund. A fund with a few very large holdings will feel those companies' days more than one where weights are spread out.
A saver who wants to see how one company's day reaches a balance needs three things: the fund held, the company's weight in that fund, and the company's move. Multiply the last two, and the result is that company's contribution to the fund's change for the day.
A single day
Thursday's numbers were a single session. Nvidia's 4.3 percent decline came after a nearly 12 percent drop during trading, and in after-hours trading the shares were up about 1 percent, AFP reported. A day's price change in one company reaches an index fund through its weight, and it reaches a retirement account through the funds the account holds.
For a saver whose horizon runs to retirement, the useful question is less what one company did on Thursday than how the fund is built: what it holds, in what proportions, and why.