Just saw State Street's latest equity forecast and it got me thinking about something most retail investors probably overlook. They're expecting the S&P 500 to return around 39% over the next five years, which sounds solid until you see what they're forecasting for mid-cap and small-cap stocks - 41% and 42% respectively. So the question becomes: should you be looking beyond the big 500?

I've been digging into two Vanguard index funds that track these smaller segments, and the numbers tell an interesting story. The Vanguard S&P Mid-Cap 400 ETF (IVOO) has returned 365% over the past 15 years with a dirt-cheap 0.07% expense ratio. The Vanguard S&P Small-Cap 600 ETF (VIOO) is right there with 360% returns and the same low fees. On the surface, that's compelling - these index funds are cheap to own and have delivered solid long-term performance.

But here's where it gets tricky. The mid-cap fund underperformed the S&P 500 significantly over that same 15-year stretch (S&P 500 returned 591%). Why? Partly because mid-cap and small-cap index funds have this structural problem built into them. When a stock does well and grows beyond the market cap threshold, it gets kicked out of the fund. Meanwhile, the losers just sit there. It's like constantly selling your winners and holding your losers - exactly what Peter Lynch warned against.

Looking at the holdings, the mid-cap fund is heavily weighted toward industrials (24%), financials (15%), and tech (14%), with names like Ciena and Coherent in the top spots. The small-cap fund leans into financials and industrials too, with more diversification but less concentrated winners. Both are well-constructed index funds with solid fundamentals, but that structural drag is real.

Here's my take: the S&P 500 is basically a collection of companies that already graduated from these smaller categories. It gets rebalanced quarterly, which means it's always capturing the most important stocks. Meanwhile, those mid-cap and small-cap index funds are fighting against their own design.

Don't get me wrong - these are good options if you specifically want exposure to that market segment. The small-cap fund will probably beat the Russell 2000 benchmark, and the mid-cap fund offers solid diversification. But if you're asking whether they'll beat the S&P 500 over the next five years? I'm skeptical. The structural mechanics just don't favor it, even with State Street's optimistic forecast.