THE PHASE PULSE
Last week, I asked what environment your money is built for.
It is a fair question, but an almost impossible one to answer without the tools to examine what you own.
So this week, I want to give you two.
Together, they answer two fundamental investing questions: how highly is this index valued, and where is its risk concentrated?
I am using the S&P 500 because its history is long and the figures are publicly available. The same questions can be asked of other stock market indexes, although CAPE data may not always be available and their historical comparisons will differ.
THE LESSON
The first measure. How the market is valued.
Price on its own tells you nothing. A company at $50 a share is not expensive or cheap until you know what you receive for that $50.
The usual comparison is price against earnings. But earnings can swing significantly from one year to the next, which can make a single year misleading. In 2009, company earnings collapsed so severely that the ordinary measure made shares look exceptionally expensive, even as prices had fallen dramatically.
The Yale economist Robert Shiller addressed this with something called the CAPE ratio. It compares price with the average earnings of the previous ten years, adjusted for inflation. Ten years covers good times and bad, so you are comparing price with a decade of results rather than one unusual year.
CAPE ratio: the current level of a stock market index with the average inflation adjusted earnings of its companies over the previous ten years.
The long term median for the S&P 500 since 1881 is about 17. As of late August 2026, it sits at approximately 42.
Here is the part that matters most. Historically, ten year periods beginning with a high CAPE reading have tended to deliver lower average returns than those beginning with a low one.
CAPE cannot tell you what happens next week. It can show whether an index is valued highly or lowly relative to its earnings history, helping to set more realistic expectations for the long term.
Valuation tells you what you are paying. But it does not tell you how widely your investment is spread.
The second measure. Where the risk sits.
An index fund holding five hundred companies sounds like five hundred evenly sized pieces. It is not.
Most indexes are weighted by size, which means the largest companies occupy the most space. But it means the label and the contents can differ more than you might expect.
Concentration: how much of an index sits in its largest holdings.
At the height of the technology bubble in 2000, the ten largest companies represented roughly a quarter of the S&P 500. Today, that figure is close to 40%, a level not seen since the 1960s.
In practical terms, $1,000 invested in the index would place close to $400 in ten companies, with the remainder spread across the other 490.
That does not mean those ten companies will perform badly. It means more of the index’s outcome depends on a small group. If market leadership changes or those businesses struggle, the effect travels through the wider index more strongly.
That is concentration risk. The investment may contain hundreds of companies, but its performance is not evenly spread across them.
THE INVESTOR MIND
Index investing is often presented as a way to remove the decisions. Pick a fund, set a monthly amount and leave it alone. That approach has genuine merit.
But passive describes how the fund is managed. It does not mean valuation and risk stop mattering.
The price paid still shapes long term return potential. Concentration still determines how much of the outcome depends on a small number of companies. Automating an investment does not make either condition disappear.
A fund can be passive. Your understanding should not be.
THE AHA
The conversation usually begins with what to buy.
It rarely begins with two more important questions: what am I paying, and where is the risk?
Valuation matters because the price paid shapes the return available. Concentration matters because it shows how much of the outcome depends on a small number of companies.
An index may contain five hundred companies and still be highly valued and heavily dependent on ten.
The name tells you what you bought. These measures tell you what you are paying for and where the risk sits.
YOUR MONEY MOMENT
Pick an index you have heard of. It might be the S&P 500, the FTSE 100 or the Euro Stoxx 50.
Find its current CAPE ratio, where one is available, and compare it with its historical median. Is the index valued above or below the level that has been typical across its history?
Then find the percentage held in its ten largest companies. Is the weight spread widely, or does a large part of the index depend on a small group?
One measure helps set your long term expectations. The other shows how widely your risk is spread.
Together, they tell you far more than the name of the index ever could.
This brings the first part of Phase First to a close.
Over eleven issues, we have moved from seeing the market as one thing to recognising the cycles, forces and decisions underneath it. This week, we added two questions for examining an index: how is it valued, and where is its risk concentrated?
The first layer of the foundation is now in place.
From here, we begin using it. We will look at what is happening in markets, the forces underneath them, and the conversations around money that are worth having.
Catherine x
Phase First.
Phase First is for educational and informational purposes only. Nothing here constitutes financial advice or a recommendation to buy or sell any security. All investing involves risk. I am a Fellow Chartered Accountant, not a regulated financial adviser. You are responsible for your own financial decisions.