Index concentration risk explained

Last updated: January 2026

You want to own 500 companies. That’s what it says on the label when you buy an S&P 500 index fund. Five hundred of America’s largest businesses, working for you. Diversification: handled, right?

Except that’s not quite what you own.

If you invested $10,000 in an S&P 500 index fund today, about $4,000 would go to just 10 companies. The remaining $6,000 would spread across the other 490. Your largest single holding would be worth roughly $750. Your smallest? About a dollar.

This is index concentration risk, and it’s hiding in plain sight.

How much of the index doesn’t matter

The S&P 500 doesn’t divide your money equally among its 500 members. It’s weighted by market capitalization, meaning bigger companies get bigger slices. A $3 trillion company has 30 times more influence than a $100 billion one.

This might have made sense when the index was designed. Large companies do represent more of the economy. But the math has drifted into strange territory.

The top 10 holdings now account for roughly 40% of the index, the highest level since at least 1972. For context, that figure was about 20% a decade ago. At the peak of the dot-com bubble in 2000, it reached only 26%.

There’s a tool economists use to measure concentration called the Herfindahl-Hirschman Index. Regulators apply it to evaluate monopolies and approve mergers. When researchers apply it to the S&P 500, they find something striking: despite holding 500 names, the index behaves like a portfolio of roughly 50 stocks—some recent calculations put the figure below 45, the lowest level observed in over 35 years.

You think you own 500 companies. Mathematically, you own closer to 50.

How the index became top-heavy

Market-cap weighting creates a feedback loop. When a stock rises, its weight in the index increases. Index funds must then buy more shares to stay aligned. That buying pushes prices higher, which increases the weight further.

During calm markets, this mechanism is mostly invisible. But when a handful of stocks capture investor enthusiasm, the effect compounds. The winners become an ever-larger share of “the market,” and investors who think they’re buying broad exposure end up making concentrated bets on whatever is popular.

Right now, the largest holdings share a common theme: artificial intelligence. They also trade at valuations well above the rest of the market. The cap-weighted S&P 500 currently carries a 29% P/E premium over its equal-weighted counterpart. When you buy the index, you’re paying more for the stocks you’re getting the most of.

No stock dominates forever

Here’s something worth considering: of the 10 largest companies in the S&P 500 at the start of 2000, only one remains in the top 10 today. That’s Microsoft, which still managed to underperform the broader index for nearly two decades before its recent resurgence.

The others? General Electric, Cisco, ExxonMobil, Walmart, Intel, Citigroup, AIG, Merck, and Pfizer have all faded from the top positions. Some delivered weak returns for years. A few were removed from the index entirely.

From the 2000 peak through the end of the decade, growth-oriented stocks were devastated. The unwinding of concentration built up during the 1990s technology bubble led to a “lost decade” in which equal-weighted and value-oriented strategies significantly outperformed.

Market leadership changes. It always has. Assuming today’s dominant companies will remain dominant requires believing something different about this cycle.

What this means for your financial plans

Many investors build financial plans around a simple assumption: the S&P 500 will return roughly 10% annually over the long term. That figure comes from historical averages stretching back nearly a century. But starting conditions matter enormously.

The Shiller CAPE ratio measures valuations against a decade of inflation-adjusted earnings and has a strong track record of predicting 10-year forward returns. When valuations are high at the start of a period, subsequent returns tend to disappoint. Currently, the CAPE sits around 38 to 40, a level exceeded only during the dot-com bubble. Nobel laureate Robert Shiller’s own forecasting model, based on the CAPE ratio, currently projects nominal returns of roughly 1.5% annually over the next decade—far below the historical 10% average.

If your financial plan requires the market to deliver historical average returns, and those returns don’t materialize, the consequences compound. A retirement projected for age 60 might need to wait until 65. An aggressive savings plan might fall short of its target.

This isn’t a prediction that the market will crash. It’s a recognition that the index you’re buying today looks different from the one that produced those historical returns. Concentration amplifies this dynamic: when a small number of expensive stocks dominate the index, your exposure to valuation risk increases whether you intended it to or not.

What happens when sentiment shifts

Index concentration risk doesn’t tell you when a correction will happen. Markets can stay concentrated for years, and the largest companies can keep outperforming longer than skeptics expect.

But concentration changes what happens when sentiment shifts. In a diversified portfolio, weakness in one holding gets absorbed by strength in others. In a concentrated one, a stumble among the largest names ripples through everything.

Consider that in early 2025, the S&P 500 fell nearly 15% as mega-cap technology stocks led the decline. The same stocks that had driven gains became the source of losses. When leadership is narrow, the path down follows the same tracks as the path up.

For investors who chose index funds specifically for diversification, this creates an awkward reality. The product no longer matches the expectation.

How Magnifina avoids index concentration risk

There’s an alternative version of the S&P 500 that weights all 500 companies equally. It contains the same stocks but distributes them evenly. Historically, this equal-weight approach has outperformed over long periods, beating the cap-weighted version by an average of 1.05% annually from 1990 through 2023. The principle has merit: avoid letting a handful of companies dominate your returns.

But equal weighting alone is a blunt instrument. It treats every company the same regardless of quality, valuation, or growth prospects. You avoid overweighting the largest stocks, but you don’t necessarily end up owning the best ones.

At Magnifina, we take a more deliberate approach. Rather than accepting market-assigned weights or applying a mechanical formula, we select individual stocks based on fundamental factors: earnings quality, financial strength, valuation, and growth characteristics. For most clients, this means allocating a portion of their equity exposure to 20-30 carefully chosen holdings. The result is a portfolio that avoids overconcentration in potentially overvalued companies while maintaining genuine diversification across stocks we’ve evaluated individually.

For institutional clients and some individuals, we offer a quantitative strategy that takes the equal-weight concept further. This systematic approach selects roughly 100 holdings weighted evenly, but filtered through fundamental screens that identify quality companies at reasonable valuations. It captures the diversification benefits of equal weighting while adding the rigor of disciplined stock selection.

Neither approach requires abandoning index funds entirely. But both recognize what a concentrated, expensive index actually provides and build around its limitations.