Your index fund is hiding massive tech-stock risk - here is how to protect your portfolio

By Wei Dai and Mamdouh Medhat

S&P 500's top 10 stocks dominate like never before. Here is a better way to invest.

Many investors' stock portfolios are closed tied to the fortunes of a few big technology companies.

We regularly hear from investors who want to know what to do about the highly concentrated and pricey U.S. stock market. The S&P 500 SPX index, for instance, had 41% of its total value in the top 10 holdings at the end of 2025, up from 19% a decade earlier. Moreover, these companies commanded a weighted average price-to-earnings of 37x, or 40% higher than the remaining index constituents.

By some measures, the largest companies command the highest percentage of the U.S. stock market going back 100 years. All of the top 10 stocks in the S&P 500 as of June 23 - about 37% of the index - are technology and AI-focused.

Investors are seeing a series of sales pitches to address these concerns. In addition to traditional stock pickers claiming these are favorable conditions for spotting bargains (what else is new?), two types of systematic approaches have gained traction: abandoning market weights for fundamental- or equal-weights to curb concentration, and emphasizing "quality" characteristics to get bang for the buck.

But these solutions are often inefficient. Research suggests investors are better off embracing a global portfolio and directly pursuing well-known, reliable return premiums, namely those associated with smaller size, lower valuation and higher profitability.

Big and expensive

There's no evidence that actively managed funds deliver market-beating returns as the market gets more concentrated.

Recent events have reminded investors that market concentration cuts both ways. In 2024, for instance, the S&P 500 returned 25%. This was driven heavily by the so-called Magnificent Seven stocks, which returned 48%. The other stocks in the benchmark index collectively returned 16%.

Beyond concentration, many investors see the high valuation ratios of the largest U.S. companies as an additional cause for unease. This narrative, however, requires nuance.

Valuation ratios can be high because expected returns are low, or because expected future cash flows are high, or a combination.

While valuation ratios contain information about differences in the cross-section of returns (i.e value vs. growth stocks), there is no reliable evidence that investors can disentangle in real time how valuation ratios may impact future returns of particular assets. The continued underperformance of traditional active management is testament to this fact.

Instead of predicting future market returns, a more efficient way to improve the likelihood of a good investment outcome is through exposure to reliable return premiums. The key is to get exposure to those premiums efficiently.

Inefficient solutions

Some wonder whether this is active management's time to shine. Heavy concentration, the argument goes, should mean ample opportunities for stock picking in more underappreciated areas of the market.

Empirically, the data suggest no relation. We compared the percentage of the U.S. market that the 10 largest stocks commanded at the end of each year since 1989, along with the subsequent three-year net-of-fees performance of active funds focused on U.S. stocks, with the latter measured as excess returns above the market.

While index concentration has increased rapidly over the past decade, the average fund's excess returns have not - hovering around zero for most of this period - and we see no discernible pattern linking the two. This holds for other measures of concentration and after controlling for differences in style exposures across funds. In short, we find no evidence that traditional actively managed funds deliver market-beating returns as the market gets more concentrated.

What about systematic options? Some popular approaches - fundamental- or equal-weights and "quality" tilts - are really just indirect ways of pursuing the size, value and profitability premiums.

Fundamental weighting de-emphasizes high market values in favor of high accounting values, a back door to value and profitability tilts. Similarly, equal-weighting is a mechanical tilt toward smaller size. These types of strategies can lead to extreme deviations from market performance and more frequent trading, which can lead to worse outcomes for investors.

With regard to "quality," the evidence suggests profitability incorporates any information about expected returns that may be captured by a long list of quality metrics, including convoluted "roll-ups" of many separate measures of firm strength. The converse, however, is not true.

What to do

Rather than relying on inefficient solutions, U.S. investors can improve their portfolio's prospects by simply diversifying beyond the U.S.

Adding developed ex-U.S. and emerging-markets stocks is a straightforward way to lower concentration. Not only do the largest stocks represent a smaller share of markets outside the US, but that share has risen more slowly. The largest 10 stocks in the MSCI All Country World ex USA Index, for example, made up roughly 9% of the total value in 2015 and 13% in 2025.

Moreover, international stocks have historically had lower aggregate valuations than their U.S. counterparts.

Investors might also pursue premiums within U.S. large-caps by tilting away from megacap growth and toward midcaps, lower valuations and higher profitability shares.

Small-caps offer another opportunity. In the U.S., valuations on large-caps continue to surpass historical averages of recent decades, while small-caps remain near their long-term trend.

Looking abroad, smaller stocks have outperformed larger firms over the past two decades, especially those small-caps associated with lower valuations and higher profitability.

Lastly, investors should want to avoid the implementation costs associated with the indexing approach that many equal-weighted and quality-focused strategies tend to use. It is well-known that tracking an index is a rigid process that carries hidden costs (from style drift between rebalance dates to trading outcomes that leave money on the table).

Choose an investment solution that provides broad diversification and a more flexible approach. Doing so will help your portfolio be less tied to the fortunes of a few companies.

Wei Dai is global head of research and Mamdouh Medhat is research director and vice president at investment firm Dimensional Fund Advisors.

-Wei Dai -Mamdouh Medhat

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06-27-26 1517ET