The giant tech stocks of the Magnificent 7 are making index funds, passive investors’ favorite safe investing tool, riskier.
While not as high as previous stellar years, the S&P 500, which tracks the broader market, still recorded a double-digit gain last year of 16.39%, several percentage points higher than the index’s 10% average annual return, not accounting for inflation, according to now-retired senior index analyst for S&P Dow Jones Indices, Howard Silverblatt.
But underneath the surface, the market’s respectable growth has been fueled by just a handful of companies, including several that make up the so-called Magnificent 7, a group of seven high-performing, tech-related companies that have driven a large amount of stock market growth over the past several years. This large concentration in the broader market is bad news for index funds, which have for decades attracted passive investors for being among the safest bets in investing, but are now looking riskier than they have in years past.
In other words, when a few mega-cap stocks do all the heavy lifting, index funds lose their value as a diversified cushion, instead rising and falling based on Big-Tech’s fortunes.
Partly fueled by the AI frenzy, the Magnificent 7 have grown to account for about a third of the S&P 500. And thanks, in part, to these AI-fueled gains, only seven stocks, including NVIDIA, Alphabet, Microsoft, and Meta Platforms, represented just over half of the S&P 500’s annual gains last year, according to a note by RBC Bank.
To be sure, the Magnificent 7 have had a mixed start to 2026, with only Amazon, Alphabet, and Meta recording a gain so far this year. Amazon was up 3.38%, Alphabet was up 8.5%, and Meta was up 4.79% year-to-date as of Wednesday.
While index funds have traditionally been viewed as diversified investments, increasing market concentration is changing this assumption. Already some of the world’s biggest investment management companies, including Vanguard and Fidelity, have made changes to their disclosures to warn investors of “non-diversification” risk.
According to the prospectus of Vanguard’s broad market fund, VFIAX, which tracks the S&P 500, the fund could at some point become technically “nondiversified” under the law that governs investment funds because of how concentrated the market is.
But, it’s the market that has changed, not the funds themselves, said Zach Levenick, cofounder of THG Securities Advisors.
“Concentration [in the stock market] is high, higher than it’s been for a long time,” he told Fortune. “And that means things in markets are potentially distorted by the weights of the very highest companies.”
How to weigh index fund risk
While index funds are still a relatively safe investment for passive investors, there have been very few periods in modern financial history in which so few companies accounted for such a large amount of market value. As stocks have gone up over the last several years, this trend has meant back-to-back double digit stock market gains and overall growth. Yet, only three years ago in 2022, stocks tanked and the S&P 500 ended the year down 19.4%, its worst annual drop since 2008.
Any bad news weighing down the market could also bring prices down quickly, because “today’s largest stocks are not only bigger, they’re also more volatile and more correlated with each other,” Charles Rinehart, the chief investment officer of the asset management team at registered investment adviser Johnson Investment Counsel, told Fortune.
While in the worst of cases nearly all portfolios may be inevitably affected, investors can act now to avoid being too overexposed to risky investments.
To avoid any extra risk or the possibility of a hit to your portfolio, Levenick said he recommends looking for value outside of the potentially overpriced tech behemoths and AI plays currently making waves. While investors can still keep their investments in tech, they may want to broaden their horizons by seeking out smaller companies with a dependable business.
“This is the time to be adjusting your portfolio to favor some stuff that maybe isn’t so expensively valued or isn’t very, very large in size,” he said. “The time to adjust your portfolio is before the bad stuff starts happening.”
