AI-Driven Market Selloff Shines Light on Concentration Risk

Big stock pullbacks expose a lack of respect for portfolio diversification.

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Jeff_Benjamin
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Wealth Management Editor
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Reviewed by: Paul Curcio
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Edited by: Kiran Aditham

If Monday’s abrupt stock market selloff had a message to deliver, it would have been geared toward concentration risk.

While the carnage took its biggest toll on artificial intelligence flag bearer Nvidia Corp., along with a raft of single-stock ETFs leveraging various forms of AI, the ripple effects were difficult to avoid because of the top-heavy nature of broad market indexes that are still being carried by a handful of stocks.

“I had several clients call me because Nvidia was the biggest loser on Monday and it was also their biggest holding,” said Craig Toberman, partner at St. Louis, Missouri-based advisory firm Toberman Becker Wealth.

“For anyone invested in the S&P 500 Index, Nvidia is probably their biggest holding,” he added, emphasizing the double-edged impact of betting big on indexes weighted by market capitalization.

It conveys a grim reality after any string of strong bull market years that the diversification a casual investor might assume from an indexed ETF allocated to 500 stocks is not really that diversified.

By Tomerman’s math, the combined weighting of the smallest 490 stocks in the S&P 500 hasn’t been this light since the dot-com bubble of the late 1990s.

“The cap-weighting is concerning, which is why we recommend not putting everything into the S&P and instead use a good world stock market index as a core for a portfolio,” he said.

Concentration Risk Runs Rampant

Ryan Graves, president of Bemiston Asset Management in Webster Groves, Missouri, underscores the concentration risk in the S&P 500 by pointing out that while the index fell by 1.5% on Monday, 350 of the underlying stocks finished the day in positive territory.

“The move on Monday highlights how concentrated the world's largest stock indexes have become around the AI trade,” he said. “To find diversification, investors have to look beyond market-cap weighted indexes.”

Stephen Kolano, chief investment officer at Integrated Partners in Waltham, Massachusetts, agreed that the broad market selloffs on Monday should be a wake-up call to investors and financial advisors about how much indexes that are promoted as broadly diversified can be whipsawed by a few stocks.

“Given the level of concentration AI has taken up in the markets, there is a broader market impact,” he said. “Yet some of the more value-oriented sectors of the market were actually up on Monday, including health care and consumer staples.”

Of course, there are other ways to gain broad market exposure without being dragged around by a handful of high-flying stocks.

The Invesco S&P 500 Equal Weight ETF (RSP) is one example; however, just as concentration comes with risk, the smoother ride of diversification might seem like a long road. Look no further than RSP’s 12-month gain of 15% versus the 24% gain by the SPDR S&P 500 ETF Trust (SPY).

Jeff Benjamin is the wealth management editor at etf.com, responsible for coverage related to the financial planning industry. This includes writing, hosting podcasts, webinars, video interviews and presenting at in-person events.


Jeff is a veteran journalist with more than 30 years’ experience covering the financial markets. He has won more than two dozen national and regional awards for his reporting. He most recently worked as a senior columnist at InvestmentNews where he wrote about investment products and strategies, as well as the broader financial planning industry. Prior to that, Jeff worked as an analyst at Cerulli Associates where he researched and wrote reports on the alternative investments industry. Jeff also worked as a money management reporter at Dow Jones Newswires, where he covered the mutual fund industry.


Based in North Carolina, Jeff is a former Marine and has a bachelor’s degree in journalism from Central Michigan University.

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