From a young age, we are taught not to put all our eggs in one basket because it is dangerous. And for decades, investors had an easy fix: They could diversify their portfolios with cheap index funds that spread dollars across hundreds or thousands of individual stocks spanning sectors, industries and themes.
Today, it is not so straightforward.
Investors are piling money into exchange-traded funds (ETFs) at a record pace to gain exposure to a basket of stocks rather than investing in individual companies. But with the explosive growth of technology companies — including the Magnificent Seven, AI hyperscalers and semiconductor makers — index funds that provide that exposure are becoming increasingly difficult.
The Vanguard S&P 500 ETF (VOO), the world’s largest ETF with under $1 trillion in assets, is renowned for its perceived diversification while charging a low average expense ratio of 0.03%. However, the 10 largest companies in their holdings now make up 36% of their portfolio.
For technology-oriented indicators, it’s worse. The 10 largest companies in the Nasdaq-100, which holds the 100 largest non-financial companies listed on the Nasdaq exchange, make up 46% of its portfolio.
That level of concentration risk is hard to ignore. For every $1 invested in a fund that tracks the Nasdaq-100, 46 cents are allocated to just 10 stocks. Another 54 cents were distributed across the remaining 90 stocks.
“It’s a problem,” said Gina Martin Adams, market strategist at HB Wealth. “And I think it’s as much a product of the economy as it is a market.”
How economic cycles affect stock market concentration
Coming out of the recession of 2022, AI has been at the forefront of companies raising their capital. That contributed to the simultaneous gains of the stock market.
Semiconductor giant Nvidia is a perfect example. The world’s largest publicly traded company by market value has seen its shares gain 917% over the past five years. It has grown so much that it alone now accounts for 7.57% of the S&P 500.
Adams says that the resulting concentration – both in the market and in the economy – can resolve itself in one of two ways: by reducing your share of losses, or by opening up opportunities to the rest of the economy.
“Finally, [AI’s gains] may begin to translate into better economic outcomes for all industries,” he said there is a risk of concentration, and that is a concern if we cannot generate positive economic momentum without AI.“
Recently, that has happened. In a July 17 research note, the Federal Reserve said evidence points to the US economy restructuring around AI, “with real effects concentrated in certain areas of the economy,” adding that high levels of AI investment precede measurable productivity gains.
Still, Adams says the laggards — particularly the housing market and the auto industry — are standing up, boosting AI’s effectiveness.
Hoping for the best, preparing (your portfolio) for the worst
While AI remains the biggest driver of both the economy and the stock market, the 493 companies in the S&P 500 beyond the Magnificent Seven are predicted to grow nearly 20% in revenue in the second half of the year, according to Adams. Tech companies are no longer the only ones benefiting from AI.
“Perhaps AI is reaching economic potential, or perhaps new businesses using AI or efficiencies are emerging,” he said. “It leads to real-time optimization without AI users.”
But the hyperscalers responsible for the market’s historic concentration face another risk: weak consumer sentiment. While most of the Magnificent Seven remain focused on AI design, they still retain important consumer-facing businesses. Amazon, Apple, Meta and Microsoft are making big money from e-commerce, smartphones, wearable technology and gaming.
Adams says consumers – burdened by high inflation, limited job growth and poor wage growth – may eventually cut back on their spending, thus posing a risk to the growth of those tech companies.
It goes without saying that index fund investing is no longer a way to provide diversification. Instead, he highlights how investors worried about concentration risk can turn to other indicators.
“The Russell 3000, for example, provides better diversification than the S&P 500,” he said, adding that tracking funds such as that index can give investors exposure to the entire US stock market. “You still get the risk of torture, but not as deeply.”
It’s a numbers game. For example, a total market index fund such as the Vanguard Total Stock Market Index Fund ETF (VTI) provides access to approximately 3,500 stocks. Nvidia still has a 6.32% weighting in VTI, but the ETF also includes smaller and smaller companies, which have outperformed the S&P 500 weighted year to date through 2026.
Alternatively, equal-weight ETFs like the Invesco Equal Weight S&P 500 Index ETF (RSP) protect investors from large losses when market-weighted technology regulators make changes and corrections. That’s because unlike their weighted counterparts, equal-weighted ETFs provide the same level of exposure to Nvidia as they do to a smaller company in the index.
Importantly, these types of funds allow investors to carefully tilt their portfolios without completely giving up on growth.
“Adding positions in value or small caps … allows you to take advantage of potential developments beyond technology,” Adams said. “But buying the S&P 500 is no longer a pure, diversified approach to equity investing.”
