While the volatility of a single stock can lead to big winnings if the company takes off, your portfolio can suffer just as easily if that firm has a bad day. Diversification can help you smooth out those lows. At least, that’s the idea.
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Unfortunately, it may not actually be possible anymore. Today, no matter how diverse your stock portfolio, its value may be largely driven by Apple and Microsoft, according to The New York Times.
“Apple, at roughly $2.4 trillion, and Microsoft, at $2.1 trillion, are so large that, taken together, the two companies would be the third-largest sector of the index, behind tech and health care,” wrote Joe Rennison, a financial reporter for the Times. “They would be larger than the energy sector and roughly the size of the financials sector.”
In fact, more than 10 cents of every dollar that’s invested in the S&P 500 flow to the market valuations of Microsoft and Apple, the paper reported.
The Dominance of Apple and Microsoft
Over the past 20 years, the stock market has become increasingly dominated by a small number of high-value technology companies. The tech sector currently accounts for about 30% of the stock market’s entire value. Of that, just six companies make up 20-25% of the S&P 500’s entire value. Collectively they’re known as the FAANG or FAAMG stocks:
- Facebook (renamed Meta)
- Google (renamed Alphabet)
Even within this elite group of tech companies, there are clear tiers of success. Meta and Netflix have market caps in the hundreds of billions, $555 billion and $152 billion respectively. Google is worth $1.35 trillion and Amazon $1.02 trillion. But Apple and Microsoft are the true heavyweights of the economy, with market caps of $2.54 trillion and $2.11 trillion, as of April 11.
To put it in context, in 2023 the U.S. economy is worth about $23.3 trillion. Microsoft and Apple, with a combined net worth of about $4.7 trillion, make up a fifth of that entire value.
What It Means for Investors
While the GDP footprint is an issue for economists, the dominance of Apple and Microsoft has created a very real portfolio problem for investors. Every stock to some degree rises and falls based on the market’s overall performance, and that performance is now tied in a very real way to the fate of these two companies. Every investor, no matter how well-diversified, is exposed to losses just because Microsoft had a bad day, even if they have nothing invested in the company.
It gets even worse for investors who hold S&P 500 indices. Index funds, particularly funds tied to the overall S&P 500, are a popular investing method. With an average annual return of 10% and market-wide diversification, many advisors recommend an S&P 500 index fund as the go-to strategy for investors who want to balance risk and growth.
Yet, someone who holds an S&P 500 fund effectively has about 10% of their money invested in Apple and Microsoft. They have a significant portion of their money sunk into the six collective companies that make up the FAANG/FAAMG portfolios. This has been good for growth over the past 15 years. Those companies have grown significantly, and have bounced back quickly from ugly market events such as the coronavirus pandemic and the collapse of Silicon Valley Bank. That has helped the stock market recover quickly in both cases, even while the economic fallout continued.
That success can cut both ways, though. Investors are exposed if either of those companies has a bad day. By occupying 10% of the S&P 500’s market cap, one of these companies can drag down the entire index on its own.
When investing in a well-diversified portfolio, an investor may trade off upside potential for protection against downside risk. But right now, it looks like diversification is getting more difficult to achieve.
How to Diversify Your Portfolio
So, for investors looking for a more balanced portfolio, what’s next? In the short term, there are two good options.
Investors who would like to pursue overall diversification can seek out not just a range of companies, but a balance of asset classes. This is often good advice since the stock market will share some systematic risk no matter how its value is distributed. In the case of a market dominated by just two companies, the argument gets even stronger.
By holding assets like corporate debt, Treasury debt, real estate and more you can invest in markets that are more insulated from the stock price of Microsoft and Apple. As with all diversification strategies, this may cap your potential gains, particularly if you invest in more stable assets like bonds.
Investors who would still like to put their money in the stock market might want to consider specifically investing in other sectors. By investing in industries that aren’t directly tied to the technology sector – such as retail or commodities – you can buy into companies that should thrive regardless of the next big operating system.
As tech stocks have grown more valuable, the stock market has gotten more concentrated. Apple and Microsoft now comprise an outsized percentage of the S&P 500’s market cap, and as a result, likely impact your portfolio more than ever before. The dominance of Apple and Microsoft – and tech as a whole – has made diversification more difficult to achieve. However, it’s still possible to construct a well-diversified portfolio with a balance of asset classes and sectors.
- If you need help spreading your assets across different sectors and investments, consider talking to a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s asset allocation calculator can help you determine the best mix of stocks, bonds and cash for you based on your appetite for risk.
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