Why Brokers Load Up on Large Cap Stocks

For many of my prospective new clients I perform a portfolio analysis before we start working together. It's a way to assess what the client has and whether the current portfolio is diversified and fits the client's long-term financial goals. So, I see a lot of the statements of the big brokers. It's amazing how often the portfolios are so concentrated on large cap stocks, mostly of the growth variety. I've puzzled and pondered over this and come to the following as the best explanation for such behavior:

• Large cap growth companies are mostly household names – Microsoft, Merck, Walmart, Abbott Labs, Citicorp, etc. Clients feel comfortable investing in companies they recognize. There’s a feeling of (false?) safety when they open their statements and see all of those names and mentally consider the all-American products and services these companies represent. Contrast this with the mostly unrecognizable names if you buy small companies or international stocks with all of those foreign-sounding names.
• Many large cap growth stocks are sexy, trendy, and have a youthful appeal. Google, Apple, and Verizon are a lot more exciting than some old, worn-out restaurant chain in the Midwest.
• When large cap growth stocks falter or gain, investors see it in the newspaper, on TV, hear it on the radio. They then expect the same when they get their monthly statements and performance reports. The paper reports only confirm what they already know.
  Investors assume that everyone else is in the same boat. When the Dow and the S&P are down, all investors are glum. So, investors just think “that’s the way things are” and are less likely to complain to the broker. In other words, there's no tracking error risk if one sticks with large caps.
• A broker is less likely to be faulted for a poor large cap pick. There’s always a ton of research from his firm and other firms saying XYZ stock is a “buy.” If something goes wrong with the pick, there’s plenty of ammo to show that the even the experts were fooled.
• Large cap stocks are a lot easier to pick and manage compared to small cap or international stocks. Just compare the expense ratios on large cap index funds (0.10%-0.30%) to small cap index funds (0.25%-0.80%). It’s a lot tougher for a broker to pick stocks outside of the S&P 500. Many brokers just opt for a small cap mutual fund (nearly always with a load and a high expense ratio). Or, the broker just sticks with the large caps and continues to charge the same commissions and fees without the heavy lifting of a truly diversified portfolio.
• Finally, many brokers just won't believe the years of evidence that's there's a "size premium," i.e., that small company stocks have outperformed large company stocks, and that diversification is the best way to obtain better long-term returns with the least amount of risk. Since many brokers will only benchmark their returns against the S&P 500, investors rarely recognize their own underperformance.

Too many large cap stocks in your portfolio? Those are the reasons why.