S&P 500 Concentration Risk: Why Advisors Warn Against Overweighting

Low-cost S&P 500 funds anchor most portfolios, and a 90/10 split between the index and short-term Treasuries has long been Warren Buffett's formula for long-term investors.

The S&P 500, covering 80% of total U.S. market capitalization, has more than quadrupled over the last decade. But popular market-weighted ETFs from Vanguard, BlackRock and State Street now carry concentration risk tied to outsized performance in information technology.

The parallels to the dot-com crash of 2000-2002 have some investors agitated. Back then, the S&P 500 lost nearly half its value.

"This S&P 500 isn't your father's index," said Mitch Goldberg, president of ClientFirst Strategy. "It's super-powered by the information technology sector, which makes up about 37% of total value. Adding in the communications sector, which includes companies like Meta and Netflix, brings it to almost 50%."

The five smallest sectors of the stock market – consumer staples, energy, utilities, real estate and materials – account for just 14% of the index, according to Goldberg. He said investors should consider an equal-weighted S&P 500 fund to gain exposure to those sectors, along with fixed income, international equity and small-cap domestic equity.

"Diversification helps you avoid becoming dependent on yesterday's winners, which is a form of recency bias," Goldberg said. "Adding non-correlated investments can improve your overall portfolio, and is important in a bear market, when you don't want all your investments to move in tandem."

Overweighting the S&P 500 also creates opportunity risk, said Todd Rosenbluth, head of research and editorial at TMX VettaFi. He pointed to small-cap and international equity funds that have beaten the index this year, including the iShares Core S&P Small-Cap ETF and the iShares Core MSCI Emerging Markets ETF.

Investments outside the S&P 500 can also offer better valuations, said Ankur Patel, chief investment officer of Ellevest. "The S&P trades around 20 times forward earnings while developed international and emerging markets sit closer to 10-15x. You're paying a lot less for each dollar of earnings overseas."

Neena Mishra, director of ETF research at Zacks Investment Research, said investors can lower volatility by turning to value strategies. She recommended dividend-growth ETFs such as the Schwab U.S. Dividend Equity ETF, which allocates heavily to health care, consumer staples and energy. "It has also significantly outperformed the S&P 500 Index this year," she said.

Within fixed income, Mishra favors shorter-term government bonds over corporate, high-yield and long-term government options. "Many investors are still scarred by 2022, when both stocks and bonds nosedived as inflation surged," she said. Longer-duration fixed-income ETFs carry higher risk in the current environment of persistent inflation and interest-rate volatility, she added.

Ultra-short Treasury bill ETFs like the iShares 0-3 Month Treasury Bond ETF and the Vanguard 0-3 Month Treasury Bill ETF have become popular. "These cash-like instruments offer low risk along with a decent level of income," Mishra said.

Gold also deserves a place in a diversified portfolio because of its low correlation with traditional asset classes, Mishra said. She pointed to low-cost options including State Street's SPDR Gold MiniShares Trust and BlackRock's iShares Gold Trust Micro.

Patel said investors should check their time horizon when deciding whether they hold too much S&P 500 exposure. "Here's one way to think about it: if the S&P 500 fell 20% tomorrow, would it change your plans? If the answer is yes, you're overexposed."

He said the key variable is when the money is needed. "Money you won't touch for 10-plus years can be more aggressively allocated. Money you need in the next few years shouldn't depend on what Nvidia reports next quarter. Buffett's 90/10 rule is fine if you have a few decades and the tolerance for it, but not if you need a down payment on a house in a few years."

The concentration risk from AI-related stocks in the S&P 500 deserves attention, Mishra said. "The information technology and communication services sectors together make up almost half of the portfolio and are dominated by AI-related names."

Goldberg said index funds have been a powerful wealth-building tool since the 401(k) made them a default for retirement savers. "But now I can't help but feel that people have heard that story for so long that they think it's a risk-less investment," he said.