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

There's a school of thought on Wall Street that investing in the S&P 500 index is a savvy way to get exposure to the best companies in the world at a low cost and a relatively lower risk than other equity investments.

Historically, that's a fair statement, as the S&P 500 has provided steady returns (with an average 10.6% annual return since 1957) while offering diversification among 500 solidly-performing US companies.

However, that diversification brand has taken a hit of late, as some high-profile stock market experts wonder if the venerable index has gained too much top-heavy weight as the new year opens for business.

A case in point.

In a December 23, 2024 X post, Kevin Gordon, senior investment strategist at Charles Schwab & Co., Inc., noted the 10 biggest S&P 500 index stocks accounted for 39.9% of the index's market cap.

The post garnered 3.5 million views and caused a sensation – and alarm – among market mavens.

"This needs to be fixed, or it will end in disaster," said Chamath Palihapitiya, a major Silicon Valley venture capital investor. "Why? In part, average Americans buy S&P 500 index ETFs because Warren Buffett told them to. They were told they would pay very little and get diversification in the 500 best companies on earth to ride out storms."

Yet as concentrations rise in a very small percentage of those stocks, the risks don't fall, Palihapitiya noted. Instead, they rise.

"If the indices don't cap the max percentage of any one stock, you essentially are holding a direct bet on that one company," he said. "In this case, see that when you buy an index of 500 companies, you're really buying 10 companies with 490 others thrown in."

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Listing Toward Technology

There could be cause for concern about the S&P 500 Index's weighting issues.

At 39.92%, information technology is far and away the largest sector represented in the index. The financial sector is the second largest component, yet only has a 12.50% weighting in the index.

Additionally, of the index's top 10 stocks, Berkshire Hathaway (BRK.B) is the only non-technology company that makes the grade.

It's understandable why the S&P 500 index is uploaded with so many technology companies. After all, those stocks have lapped the field in recent years. But as Wall Street historians frequently say, past performance is not indicative of future results.

"Much of the earnings growth in the past few years has come from a handful of some of the largest tech companies," said Justin Zacks, vice president of strategy at Moomoo Technologies Inc., an online trading platform. "This earnings growth has supported higher stock prices. Investors have naturally gravitated towards these stocks, pushing prices even higher on hopes that future growth will continue, supported by the development of artificial intelligence."

The Magnificent Seven stocks alone account for about a third of the market capitalization of the S&P 500, and that's a problem. "Poor performance from even just one of these stocks could significantly affect investors' returns," Zacks noted. "It's important to realize that the index is less diversified than it was 10 or 20 years ago due to the high concentration at the top."

That's especially the case as the sector heavyweights take on more business risk.

"Many of these large tech companies have spent and are planning to spend significant sums on building their AI infrastructure," Zacks added. "If this spending doesn't start accruing to the bottom line in 2025, it may disappoint investors. High expectations and high multiples exacerbate the risk if something goes wrong."

Don't count on the rest of the S&P 500 to fill the void if something goes wrong.

"The outsized gains in just a few of these companies may also be masking weakness in the corporate economy more broadly," Zacks said. "About a third of S&P 500 stocks finished 2024 in the red despite an over 23% return for the index overall."

Next Steps for Investors

Investors wondering about potential risks with a top-heavy, tech-heavy S&P 500 index in 2025 should talk to a trusted financial advisor and factor in the risks and rewards of leaning too heavily in one market direction

"For Main Street investors, the pros remain clear: exposure to high-growth, industry-leading tech companies and a relatively straightforward investment vehicle for long-term wealth building," says Christina Qi, CEO at Databento, an on-demand market data platform and founder of Domeyard LP, a high-frequency trading hedge fund. "However, the cons lie in the reduced diversification and potential for increased volatility if these top stocks stumble."

Investors may need to be more mindful of balancing their portfolios with other asset classes or indices to avoid overexposure to the same handful of companies, Qi advises. "In 2025, smart diversification will be critical for mitigating the risks associated with this concentrated market structure," she said.

It's also worth noting that investing in index ETFs, even when they are top-heavy, still provides investors more diversification than an investment in a single stock, Zacks said.

"The S&P 500 can provide investors with a broad exposure to the overall market," he said. "Just realize that on a sector basis, that exposure is more heavily weighted towards technology stocks than it has been historically."

One way to lessen this exposure is to choose an ETF "that tracks the S&P 500 equal weight index as opposed to the S&P 500 market cap weight index," Zacks added.

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