Advisors Are Moving Beyond the Magnificent Seven

If ever there was a time for diversifying, it is now.

A broadly diversified portfolio is a foundational component of long-term investing. But as most financial advisors would attest, diversification sometimes means making difficult decisions about selling high and buying low.

Enter the lopsided reality of the Magnificent Seven stocks that have been responsible for a disproportionate share of broad market performance over the past few years.

The seven companies—Alphabet Inc., Amazon Inc., Apple Inc., Meta Platforms Inc., Microsoft Corp., Nvidia Corp. and Tesla Inc.—represent about 30% of the market-cap weighted S&P 500 yet have contributed nearly 65% of the index’s performance over the past year.

But financial advisors and market analysts are now encouraging investors to take a few steps back and appreciate some of the risk that might be building at the top of some of the most popular index strategies.

“We think that shifting equity allocations to both quality growth midcap and large-cap companies, as well as higher growth and more innovative emerging growth small-cap companies could reward investors as the market likely broadens,” a report published earlier this month by San Francisco-based Osterweis Capital Management says.

The report, co-authored by co-chief investment officer Nael Fakhry and portfolio manager Bryan Wong, offers advisors a takeaway to show clients how diversification has worked over time.

The market-cap-weighted S&P, dominated by the strongest performers, produced a 15% annualized return over a five-year period through March, while an equal-weighted version of that same index gained just 11%.

But over the past 20 years, cap-weighted and equal-weighted both saw 10% annualized returns. And over 30 years, the equal-weighted S&P gained 11% annualized, beating the cap-weighted version’s 10% return.

Mag Seven Weakness

With both Tesla and Apple shares in negative territory this year, the Mag Seven is showing signs of weakness. Fakhry and Wong have multiple examples of how the mighty can fall.

Just 10 years ago, for example, both Chevron Corp. and Wells Fargo & Co. were among the 10 largest companies in the S&P. Today they don’t even make the top 20.

And for anyone thinking the top 10 companies by market cap is all you really need, the Osterweis report points out that since 1980 the top 10 stocks in the S&P 500 underperformed the index by 2% and 2.3% annualized over the next three- and five-year periods, respectively.

“The key word is ‘diversify,’” said Chris Shuba, chief executive of Granite City, Calif.-based Helios, which provides quantitative research services for advisors. 

“I wouldn’t argue to completely divest from the Mag Seven, but diversification could be very beneficial at this stage,” he added.

Nicholas Codola, senior portfolio manager at Orion Advisor Solutions in Omaha, Neb., advises caution when it comes to the Mag Seven at this point.

“We’re staying invested in them but taking some wins and looking elsewhere for opportunities is a prudent approach to investing,” he said. “To do otherwise is to leave the portfolio returns up to fate.”