Even if you have been doing everything right and diversifying your investments as the textbooks suggest, you may be taking greater risk than you realize.
What’s happened is that a handful of companies, like Nvidia, Microsoft, Alphabet and Apple, have been driving stock returns. They, and a handful of other tech giants, including Amazon, Broadcom, Meta and Tesla, have become so valuable that their shares dwarf the rest of the market. That’s well known, and even applauded, because these gargantuan stocks, many of them spurred by investor enthusiasm for artificial intelligence, account for an outsize portion of the wealth that many people have gained in the market over the last three years.
But there’s a downside that isn’t as well understood. The market has become so highly concentrated that even the most comprehensive U.S. stock index funds are no longer well diversified. In fact, by a strict legal definition, they now are not diversified at all. If you believed that by buying an index fund that mirrored the entire stock market you were being protected by true diversification, it’s time to re-evaluate this crucial assumption.
Why Spreading Risk Matters
The adage “don’t put all your eggs in one basket” is a reasonable starting point for thinking about long-term investing. It basically means owning a sufficient variety of securities to give yourself protection if some of your holdings run into trouble.
Holding broad index funds is a standard way to accomplish this. Owning a bit of everything in a publicly traded market is usually said to give you plenty of diversification. The vast literature on finance has suggested this for more than 50 years. While I believe it’s still largely true, it isn’t entirely correct. The situation has changed for the first time since the advent of widely available index funds in the 1970s.
Simply by tracking the stock market, S&P 500 index funds contain several stocks that each account for more than 5 percent of the index — with Nvidia itself making up 7.8 percent of the market on Dec. 31, 2025, according to final data from Howard Silverblatt, senior index analyst for S&P Dow Jones Indices, who retired earlier this month.
Apple accounted for 6.9 percent of the index, Microsoft for 6.2 percent. And Alphabet, the holding company for Google, made up more than 5.6 percent of the index, when you include both of its share classes. Combined, the total value of the four stocks was equal to more than 26 percent of the S&P 500.
I was aware of these numbers but didn’t connect them directly to the issue of portfolio diversification. A reader brought this problem to my immediate attention recently. Fidelity Investments had sent her and other fund shareholders a letter saying that since Nov. 10, two major index funds, Fidelity 500 and Fidelity Total Market, were operating as “nondiversified funds.” She wanted to know whether the funds had changed in an important way. Why weren’t they still diversified?
When I looked into it, I found that the funds themselves haven’t shifted their approach one iota. In an emailed statement, Fidelity said, “The benchmarks of those funds remain the same.” They are still carefully tracking the stock market, as they have since their inception.
Instead, what has changed is the U.S. stock market itself. It has become so top-heavy that index funds mirroring the overall market are breaching legal thresholds for diversification set by the Securities and Exchange Commission to protect investors. Fidelity was merely notifying its customers that it was making a legal adjustment in its funds acknowledging this shift — something, as I learned, that Vanguard, State Street, BlackRock and other companies with similar funds had already done in their own legal filings.
5% and 25%
Vanguard began making changes in disclosures for its broadest U.S. stock index funds in 2024, Michael W. Nolan, a Vanguard spokesman, told me. Five years earlier, the S.E.C. had given index funds the authority to operate in a nondiversified way, as long as they disclosed that change to shareholders and if it happened solely because the market had itself become nondiversified. The issue arose in 2019 for funds tracking so-called “growth” indexes, which focus on rapidly expanding companies, many with a tech orientation. The rising stock market value of the big tech companies made these indexes extremely concentrated.
But now, that concentration has become so acute that it has made broader market indexes nondiversified, too. As Vanguard puts it in the prospectus of its Vanguard 500 Stock Index Fund, investors now need to be aware of “nondiversification risk.”
“Because the fund seeks to closely track the composition of the fund’s target index,” the prospectus says, “from time to time, more than 25 percent of the fund’s total assets may be invested in issuers representing more than 5 percent of the fund’s total assets due to an index rebalance or market movement, which would result in the fund being nondiversified under the Investment Company Act of 1940.”
There is a danger when a fund becomes that concentrated, Vanguard warned. “The fund’s performance may be hurt disproportionately by the poor performance of relatively few stocks, or even a single stock, and the fund’s shares may experience significant fluctuations in value,” the prospectus said.
In other words, if the biggest trees fall, everyone will feel the forest shake.
This isn’t merely a problem for investors in S&P 500 funds, which is limited to the biggest stocks in the market. The issue goes far beyond that. The entire U.S. stock market is now nondiversified, using the classic definition. This is true whether you use the Dow Jones U.S. Total Stock Market to define the stock market, which is what Fidelity does with its Fidelity Total Stock Market Index Fund, or whether you measure the market with the CRSP US Total Market Index, as Vanguard does for its Vanguard Total Stock Market Index Fund.
The stock market itself may fix the nondiversification dilemma. The market will become diversified again if the biggest stocks decline more rapidly in value than the smaller stocks. But if you’re holding broad, no-longer-diversified funds when the market corrects itself, you will be hurt.
Protect Yourself
So what does this mean for ordinary people? Simply put, for investors, I think it’s inescapable that at least this respect, the overall U.S. stock market isn’t as safe as it has been for more than 50 years.
Note that I’m talking here only about market concentration, much of it caused by the tech boom linked to A.I. Other, bigger headline issues facing the nation and the world are affecting the markets, too. These include the civil unrest in Minnesota set off by violent immigration crackdowns, the Trump administration’s pressure on the Federal Reserve, its use of tariffs to punish erstwhile friends, its threats to seize Greenland and its capture of the former president of Venezuela. I’ll come back to the market implications of such issues in future columns.
Market concentration has never reached this extreme level in my adult life. But it was commonplace until 1967, according to an analysis by the Vanguard Investment Advisory Research Center, using historical data from the Center for Research in Security Prices. The study went back to 1925, and at the start of every year from 1925 through 1967, the five biggest stocks — companies like AT&T, U.S. Steel, General Motors and Standard Oil of New Jersey — accounted for at least 25 percent of the value of the entire U.S. stock market. I wouldn’t want to return to the worst aspects of that long era, which included the Great Depression. Stock returns were volatile.
But because the U.S. market has produced great returns over the long run, including in many, if not all, of those top-heavy decades, I believe it’s still wise to invest in stocks, and to use cheap, broad, low-cost index funds.
Bad times will return to the stock market, however, as they periodically do. For reducing risk, it’s always been wise to also hold cash and bonds, and to make sure that both your stock and bond investments include broad international allocations as well. Now, given the concentration in the U.S. market, it’s even more prudent to do so.
The rise of big tech stocks has been a wealth-building marvel, which may continue for years. Should the giants stumble and fall, broad diversification will be a balm. But it’s hard to get it now by investing in the U.S. market alone.
Jeff Sommer writes Strategies, a weekly column on markets, finance and the economy.
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