Why the S&P 500's Tilt Is a Danger to Your Portfolio

Many investors see the S&P 500 index as a smart choice for gaining access to top-performing companies at low costs and with less risk than other stock investments.

Traditionally, this has been true. The S&P 500 has offered consistent returns, averaging 10.6% annually since its inception in 1957, along with a degree of diversification across 500 well-established US companies.

Recently, however, experts are expressing concern about the index's structure, suggesting that it may be becoming too skewed toward a few top companies as we enter the new year.

For instance, Kevin Gordon, a senior investment strategist at Charles Schwab, pointed out in a social media post that the top 10 stocks in the S&P 500 now make up nearly 40% of the entire index's market capitalization. This alarming trend has caused discussions among investors.

Investment guru Chamath Palihapitiya warned, "This needs to be fixed, or it will end in disaster." He cited the fact that many average investors buy S&P 500 index funds based on the advice of industry leaders like Warren Buffett, who recommended these vehicles as a way to secure a diversified portfolio of America’s best companies.

Unfortunately, as the importance of a small group of stocks increases, the associated risks do not decrease. Palihapitiya commented, "If indices don’t limit how much of any one stock can impact the index, you are essentially making a big bet on just a few companies." In reality, purchasing an index of 500 companies may mean that you're mostly investing in just 10 firms with the remaining 490 acting as minor components.

Sector Concentration Issues

This shift leads to concerns about the sector concentration within the S&P 500. The information technology sector currently dominates the index with a weight of about 39.92%. In contrast, the financial sector holds a far smaller share at just 12.5%.

Moreover, among the top 10 stocks in the index, only one company—Berkshire Hathaway—is not in the technology sector.

This heavy presence of tech stocks makes some sense, especially given their exceptional growth over the past few years. However, historical market wisdom reminds investors that past performance does not guarantee future outcomes.

Justin Zacks, a vice president of strategy at Moomoo Technologies, noted that most earnings growth these days has come from a small number of tech giants. As investors continue to chase these high-performing stocks, their prices are driven higher by expectations for future growth, particularly in areas like artificial intelligence.

The so-called "Magnificent Seven" tech stocks alone constitute about a third of the S&P 500's total market cap, which raises significant risks. Zacks cautions, "A poor performance by even one of these leading companies could drastically reduce returns for investors." He further emphasizes that the index has become less diversified compared to 10 or 20 years ago due to this concentration issue.

This risk becomes even greater as these dominant companies face more operational challenges. Zacks elaborates, "Many of these large tech firms are heavily investing in AI infrastructure, and if these expenditures don’t show benefits in the near future, investors could be disappointed. High expectations paired with high stock valuations can lead to trouble if things go awry."

Investment Strategies Going Forward

With the S&P 500 becoming top-heavy and overly reliant on the technology sector, it’s crucial for investors to consider the associated risks. Consulting a financial advisor can be a wise step to evaluate the potential benefits and drawbacks of investing heavily in one particular direction.

Christina Qi, the CEO of Databento, explained that while the benefits of investing in strong tech companies are clear, the downsides include reduced diversification and higher volatility risks if these leading stocks falter.

To mitigate risk, Qi suggests that investors should diversify their portfolios across different asset classes or indices to avoid being overly exposed to a select few companies. "In 2025, smart diversification will be essential to manage risks connected with the concentrated nature of this market structure," she advised.

Despite the risks involved, investing in index ETFs, even those that may be top-heavy, still offers more diversification than investing in individual stocks. Zacks adds, "The S&P 500 can give you wide market exposure, but be aware that it leans more towards technology stocks now than in the past."

One way to decrease this concentration is by opting for an ETF that follows an equal-weight S&P 500 index rather than a market-cap weighted version.

S&P, Investment, Risk