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NerdWallet's Smart Money Podcast
Are Index Funds Still Diversified? Concentration Risk and a Top-Heavy Market
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If you are feeling like you're behind on your retirement savings, well, join the club. Sometimes it feels like if you're not putting your pinky finger to the side of your mouth while stroking a white cat and talking about a minimum of $1 million in your accounts, you're behind. But there are ways to catch up and we're going to outline them for you. Welcome to NerdWallet's Smart Money podcast where you send us your money questions and we answer them with the help of our genius nerds. I'm Sean Pyles.
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B
And I'm Elizabeth Aiola. Later this episode we'll be discussing catch up contributions and how to fund accounts maximum benefit. But before that, we have our weekly Money news roundup where we break down the latest in the world of finance to help you be smarter with your money. Our news colleague Ana Hillhosky is here to talk about index funds and why the standard advice to set it and forget it. I love doing that. Might not ring true anymore. No. Ana, welcome back.
- [03:46]
D
Thanks, Elizabeth and Sean, for a long time, buying an index fund was the standard advice for the average person who wasn't day trading and wanted their money to grow without having to think about about it very much. But index funds aren't as spread out as they once were and that's because a small group of companies and now make up the biggest slice of the market. And that means your investments are a little bit more concentrated than you might expect. So today Ryan Sterling, a wealth advisor with NerdWallet Wealth Partners, is joining me to talk about concentration risk, what it means for your money and if there's anything you can really do about it. Ryan, welcome to Smart Money.
- [04:20]
E
Yeah, thanks for having me.
- [04:22]
D
So from my understanding, concentration risk is when a handful of companies are basically running the stock market. Is that an oversimplification?
- [04:30]
E
Yeah, I think it is a slight oversimplification. I mean to just to take one step back. So when you're talking about index funds, most people are talking about is the S&P 500. So an index fund tied to the S&P 500. So the S&P 500 is what's called a market capitalization weighted index. Okay, what does that mean? That effectively means that they take the top 500 companies, they rank order them from the biggest one all the way down to the smallest, and then they're weighted according to size. So to the point that you just made the largest companies get a larger weighting in the index than smaller companies, Historically speaking, when you look at the top 10 companies in the S&P 500, they've represented about 18 to 20% of the total index. So going back through history, you know, the top 10 have accounted for a large portion of the index. But when you think about 20% of the top 10 companies and then 80% being the rest, it really isn't that much cause for concern. Okay, so today what's happened is the top 10 companies have grown in size to be now representing about 40% of the index. Which now you're starting to see headlines that, hey, is the S&P 500 over concentrated? Do you really have the diversification you just alluded to? So that is true. There's a but though. The but is the reason these companies have grown to the size that they are today is because they're really top performing companies. They have strong balance sheet, they have durable moats and competitive advantages, they have tremendous free cash flows, and they've been really good allocators of capital over time. So, you know, if you look at the companies like, you know, Google or Apple or Amazon, they're big because they deserve to be big because they have grown so much over the years. So when I think about the S&P 500 and I think about that market capitalization weight kind of being the driver of size of companies in the portfolio, you know, I oftentimes see that as a feature, not a bug, in the sense that the companies that are performing the best over time will command a higher weight than the companies that aren't doing as well over time.
- [06:46]
D
Got it. So you mentioned looking back a little bit into history. So has the market ever been quite this top heavy before?
- [06:52]
E
You know, not this top heavy, but there have been times where the top 10 companies have represented more than 30%. Going back to the late 90s, early 2000, it topped up at around 29%. When you go back to the early 70s, it was also kind of in the high 20s, low 30s. Why some people are alarmed right now is because those two periods were followed by recessions and bear markets. So there's this concern that okay, is this going to follow suit? And I think it certainly warrants paying attention. But this is another interesting case study and that's going back to 1932. So in 1932, the largest company in the S&P 500 was AT&T and it represented around 13% of the entire market. In contrast, the biggest company today is Nvidia and Nvidia is around 8%. Okay, so how did the market do in 1932 with a concentration with one company representing around 13%? Well, over the next 30 years, the market annualized at around 16% a year. So one of the best 25 year periods we've ever seen. So the way that I take this is to say, okay, is the concentration a cause for pause? Absolutely. Is it a definitive. When it gets this concentrated, it will lead to a bear market. It's not quite that tight of a relationship, but it certainly does bear paying attention to.
- [08:17]
D
So if a few companies are dominating the index, do market swings end up feeling bigger than they actually are?
- [08:23]
E
They can, yeah. I mean, when you look at again, Nvidia at around 8%, if Nvidia stock drops 50%, that's going to be 4% in terms of their attribution to total return. Like the market will certainly feel that at the same time, and I think this is potentially sort of a bigger concern than the concentration in and of itself is that you do see a lot of correlation between these companies at the top. So for example, if Nvidia is down 50%, that probably means Google's going to be down, that probably means Microsoft's going to be down, that probably means Amazon is going to be down. So it's not just one company being down, you know, 50%, it's that basket of where there's a lot of correlation between them all likely being down at the same time. So you know, when I look at the top 10 companies today, as I mentioned, it's Nvidia, it's Apple, it's Microsoft, it's Amazon, Meta, Google, Tesla, Berkshire Hathaway, Eli Lilly, Broadcom. When I look 15 years ago, just 15 years ago, a lot of the same companies, but you had Exxon Mobil, you had Wells Fargo, you had JP Morgan, you had General Electric. So you could argue that going back in time that that top 10 weighting was a bit more diversified than we are today. So again, that concentration, it's not necessarily just the top 10 making up 40%, it's also the fact that they seem to be correlated to each other as.
- [09:50]
D
Well in a highly concentrated Market like we have right now. Are investors more vulnerable to market swings?
- [09:57]
E
I would say yes. And you know, the what we're. One thing that we're talking to our clients about right now is when, when we look at the biggest risk facing financial planning and our clients financial plans, it's the risk of a lost decade. And that's where you have a 10 year period where the market is negative. Now the last time we saw a lost decade was from the late 90s to 2008. So if you invested in the S&P 500 on January 1, 1999 and you opened up your statement on December 31, 2008, you were negative over that 10 year period. That's very damaging for financial plans where we're counting on having some tailwinds for the market to help propel plans forward. Okay, so how do you protect against the lost decade? Well, that's where you further diversify. You include mid cap stocks, you include small cap stocks, you include non US developed, you include emerging markets, you include some bonds, real estate, investment trusts, et cetera. So when we look at a portfolio that back in 1999 that had small caps, that had mid caps, that had international, that had emerging markets, that had bonds, that composition was positive over that 10 year period. So what we're looking at today, and one thing that we're telling clients is we're not necessarily calling for a bubble or a bear market to start, but we are concerned as we're looking at our financial plans to say what if we do see a loss a decade, how do we protect against that? And that's where you further diversify outside of just the S&P 500.
- [11:31]
D
So looking back on that lost decade, are there parallels to today that you see in terms of what led up to it?
- [11:37]
E
Yeah, I mean, you know, what we saw back in the 90s was we saw a structural tailwind being the Internet and the rise of.com companies. And look, the Internet was real and the Internet was something that, you know, was a real structural tailwind that's created a lot of efficiencies and a lot of growth. And I think we've all benefited from the Internet revolution. I think AI is very similar in that AI is a real structural tailwind. AI is going to make us all more efficient. There's going to be disruptions along the way, there's no question about it. But I think, you know, looking back atthe.com and looking at the rise of AI, I think it's very likely that we will see an AI bubble At some point, I don't know that we're there yet, but these things are impossible to call the tops. So that's where again like further diversifying outside, where you know I mentioned the mid caps, the small caps International, you know, we're also including dividend paying strategies as part of our portfolio as well to again further diversify away from that mega cap tech.
- [12:34]
D
So does all this mean that the old by the market advice is outdated at this point?
- [12:39]
E
I mean it, it depends on how you define the market. Right? I mean we, we are fully invested in the market. We are believers in the market. I'm fully invested personally in the market. So you know, we are firm believers that you need to be invested in the markets. But I think take a step back of what index funds mean. And you know, it's hard when you talk to people that say oh gosh, like are index funds, are they dangerous right now? It's like, well there are a lot of index funds out there. So you know, when you think about passive strategies, again, the S&P 500, that passive strategy, that index fund, that, that passive ETF, that's a core part of our portfolio today. It's going to remain a core part of the portfolio. There are index funds that are tied to dividend paying stocks. There are index funds that are tied to mid cap, small cap and all the asset classes I mentioned. You can buy comparable index funds that replicate the indices of those various asset classes that are a very tax efficient, low fee way to get exposure to these different asset classes. I would also say that when you're constructing a portfolio, every single line item in your portfolio should serve a specific purpose. So what do I mean by that? I come across people all the time that say, hey, I have three tickers in my portfolio that are all broad based index funds so I feel Safe. I've got VTI, spy and QQQ. There's like a 90% correlation between all of those. You're basically owning the same thing. It's just in three different tickers as opposed to one. So when we look at it again, when we think about how do we want to construct portfolios, we want to use those index funds that each play a very specific role and to minimize the amount of overlap that we have between the various index lines.
- [14:18]
D
Got it. Sometimes people are going to say don't worry, the market will sort itself out. Is that just a reassurance or is it another way of saying that index investors are going to take a hit?
- [14:29]
E
I am a huge proponent of the stock Market as a way to build wealth over time. When you look back at just the core of why has the market grown over time? It really comes down to two things. Progress and innovation. That's the story of human civilization, of human history. That's not stopping anytime soon. Bet against that at your own peril. So, you know, when I look at it, I think I want to be exposed to and I want to benefit from that progress and innovation. And the only way that you can do that is to be invested in markets. Now, does that mean we're not going to see some challenging markets? That we're not going to see bear markets? I can also guarantee you that we will see bear markets over the next 10 years. That's just going to happen. The way to make money over time is never fall into one or two camps. Never be a forced seller, and never be a panicked seller. So the way to not be a panic seller is to make sure that you don't take every headline and internalize it. As well as having a professional talk to you does help. The way to avoid being a for seller is don't be overly leveraged. Make sure you have an emergency savings fund. Make sure any known liability that you have in some sort of cash or cash equivalent so that when the market does fall 30, 40% or so, it's not going to feel good. But so long as you're not a force seller, you can wait for the market to recover and the market will recover because of those forces of progress and innovation over time.
- [15:54]
D
But should the average investor be rethinking how they're constructing a diversified portfolio?
- [16:01]
E
Yeah, absolutely. Once again, I think people need to be adding more international as part of their portfolio. I think bonds play a role in a portfolio. People say all the time, you know, hey, I'm young. Why do I need bonds? Bonds provide current income, but they also mute volatility. And, you know, when you look at bonds right now at 4% or so, I'll take a 4% income to have some sort of stabilizing force in the portfolio. You know, I also, I keep going back to small caps and mid caps. You know, when you look at the valuation disconnect between large caps and small caps, it's the largest that we've seen since the late 1990s. Okay, so what happened after the late 90s? Well, small caps outperformed large caps in a meaningful way. Non us outperformed us in a meaningful way. So again, this goes back where history does rhyme. We're not calling for this to happen tomorrow. But we do think broadening out the allocation to include more asset classes that aren't as. Yes, there's some correlation, but you don't necessarily see the same overlap things is really important for investors because if you're just 100% in the S&P 500, I think the biggest risk that you face today is that you see a lost decade.
- [17:08]
D
So if you're someone who is working on diversifying, are there any other ways that people can manage or reduce their exposure to concentration risk?
- [17:17]
E
Yeah, I mean, it goes back to, again, looking at the different line items in your portfolio. So the different investments in the portfolio and looking in and digging to see is there overlap? Because again, you could have 10 different funds in your portfolio, but all 10 funds could contain all the same stocks and all be the same strategy. So there's a lot of overlap within index funds. So I think, again, knowing what you own and being crystal clear in terms of every investment that you make in your portfolio, knowing the role that it plays in the portfolio.
- [17:50]
D
Got it. All right. Well, Ryan, thank you so much for joining us today. Really appreciate it.
- [17:54]
E
Yeah, thank you so much.
- [17:56]
B
Thank you, Ana and Ryan, for reminding me to take a look at my portfolio and make sure the index funds that I'm invested in are diverse enough. Once again, Ryan is a wealth advisor with NerdWallet Wealth Partners. If you're considering working with a financial planner like ryan, then visit nerdwalletwealthpartners.com we're going to include a link to that site in today's episode description.
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A
Up next, we answer a listener's question about ketchup contributions and how to fund accounts for maximum benefit. But before we get into that listener, you know the deal. This is a show that runs on your financial questions, so send them our way.
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Maybe you're trying to figure out how to diversify your own portfolio, or you're a new investor and want to know the way to get started in the market. Whatever your money question is, we want you to text us. Leave a voicemail at 901-730-6373. That's 901-730-N E R D. We see you guys. Comments. So please leave a comment on Spotify or you can email us@podcasterdwallet.com in a moment.
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This episode's money question stay with us.
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Services not available in all areas the following is a paid sponsorship, not an endorsement by NerdWallet's editorial team. Today's episode is sponsored by Bilt.
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BILT cards are issued by column NA member FDIC pursuant to license for Mastercard International Incorporated. We are back and we're answering your money questions to help you make smarter financial decisions. This episode's question comes from Batilda via Spotify. Yes, we do take listener questions via Spotify and we love comments too, so please leave them for us. All right, here's the question. In a future episode, can you talk about catch up contributions for higher earners only being allowed in Roth 401k versus traditional? Not sure that I understand what FICO wages are.
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C
Batilda, to help us answer Batilda's question is no. 1. Elizabeth and I are taking this on ourselves this episode. So I'll start with a rundown of how ketchup contributions work, how you qualify, and how much you can tuck away. Ketchup contributions allow people in the later stages of their working years to save extra for retirement. Using workplace retirement accounts like a 401k, 403b or even non workplace accounts like IRAs, you become eligible on January 1st of the year that you turn 50. In terms of how it works, you first max out your retirement accounts, be it a 401k or an IRA, and then you can save an additional amount with the catch up contributions. You can make catch up contributions to multiple accounts, but your contributions across your retirement accounts shouldn't exceed the limit. And a fun fact for the history buffs out there, ketchup contributions became a thing in the early 2000s and were just around $2,000 back then. They're much higher now.
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B
In the early 2000s I was busy wearing bell bottoms and watching music videos.
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C
So yes, same here. Low rise jeans and a lot of Madonna and Cher for me.
- [23:24]
B
Yes, good taste on as a child.
- [23:26]
C
Yeah. Okay, well Fast forward to 2026. You can make an $8,000 catch up contribution to a 401k and a 1, $100 catch up contribution to an IRA. This is in addition to the annual contribution limit on those accounts. The catchment contribution limit and rules vary depending on the type of account that it is. Super ketchup contributions were introduced in 2022 with the Secure Act 2.0. It allows folks from 60 to 63 a higher catch up contribution amount of $11,250 to a 401k, 403b and 457 plans and thrift savings Plans. So you can make both traditional and Roth catch up contributions. But because of some recent changes, a lot depends on your income as Batilda was alluding to.
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B
Right. Bathilda mentioned changes to how high earners can make catch up contributions. This year. Now the change states that if you are a high earner making fico wages over $150,000, then you have to make those contributions to a Roth account. And that Roth account can be an IRA. It could be a 401k, anything of the likes. Now let's answer Batilda's question about what FICA taxes are first and then we can look at the implications of the new changes. FICA stands for Federal Insurance Contributions act and is federal payroll taxes that fund some social insurance programs. Now both you and your employer contribute to this tax. 6.2% of your gross income goes to paying Social Security tax and then another 1.45% goes to Medicare taxes. Good thing is that your employer matches each of those contributions so you're not paying the whole thing yourself. And also it's worth noting that FICA taxes are separate from your federal income taxes that you pay. And then really quickly, because I always hear about this all the time, I want to add that a common misconception about FICA taxes is that they're like a savings account for your future retirement benefits. I'm sorry to break it to you, but they're not. Now those taxes help to pay benefits for people who are currently retired and for other benefits like disability, surviving spouses and the likes of. Now anything that isn't used goes towards Social Security trust funds and it's invested in special issue U.S. treasury securities.
- [25:42]
C
That's probably more than anyone thought they would ever want to know about FICA taxes. But it is helpful to know where your money is going. These taxes aren't just going into the abyss, at least not all the time. It's going to help people with their benefits. So it's nice to know. All right, so I'm going to pivot to the new changes to catch up contributions and why they've been made back to the Secure 2.0 Act. As we mentioned, this act made it so people who make more than $150,000 from the year before have to make after tax contributions into a Roth beginning January 1st of this year 2026. Prior to this rule, there was no income cap for the catch up contributions and the type that they were.
- [26:19]
B
A downside of this new rule is that if you are earning more now than you anticipate you would have say during retirement you're likely going to end up paying more in taxes. I know that sucks. But on the other hand, if you were able to defer your taxes until retirement, you could potentially pay less in taxes. Obviously depending on where Tax rates are when you would potentially retire in some time in the future. Are there any other downsides of this new rule that you can think about, Sean?
- [26:43]
C
Well, a smaller paycheck is probably the most obvious one here. There are some other benefits of this change too, including tax free withdrawals in retirement. Also, Roths aren't subject to required minimum distributions of the original owner of the account. And you face that with something like a 401k. So that's more money that you can leave to grow in the market or leave for your beneficiaries. The new rule also potentially forces you to diversify your tax situation, which is a plus if you haven't done that so far.
- [27:10]
B
That's right. Now, for people who are bummed about the recent changes and who earn close to the $150,000 cap, one of the things that come to mind that you can do is looking for ways to lower your taxable income. You can do that through making contributions to a health savings account. Did you guys know I love health savings accounts? Yes, I do.
- [27:28]
A
Me too.
- [27:30]
B
So they do have triple tax benefits, which is why I love them so much. So you can make tax deductible contributions, you get tax free growth, and also you can make tax free withdrawals on qualified expenses.
- [27:41]
C
Something else I'm thinking about here is how many people even make ketchup contributions? We know that a lot of folks aren't saving nearly enough for retirement. So are people even maxing out their accounts enough to be able to make ketchup contributions?
- [27:53]
B
That is a wonderful question, Sean, and I have an answer for it because I look only 16% of eligible participants, those who are 50 and older, actually made catch up contributions to their employer sponsored plans, according to the latest Vanguard how America saves 2025 data. Now, as you said, Sean, that's probably not shocking as a small percentage of people, that's about 14%, actually max out their account anyway. And those are the people who catch ups might make the most sense for. Honestly, it's probably a good idea for folks to utilize these catch up contributions if they have the means to, because it gives you a chance to bulk up your retirement savings and also capture all of those yummy benefits, whether it's a Roth or traditional retirement account. All right, Sean, Mr. CFP, I want you to give us an example of how catch up contributions could boost retirement savings. Let's look at the numbers.
- [28:43]
C
Okay, I'm going to talk about a lot of numbers, so maybe pull out a pen and paper or just get your brain ready for that so let's say Denise is 50 and has current retirement savings of $350,000 in a 401k. The annual rate of return on her investments is, let's say, 7% and she plans to retire at 65 in 2026. The standard 401k limit is $24,500 and the catch up contribution for those 50 or older is $8,000. As we said before. So Denise can contribute up to $32,500 per year. So if she diligently did that over the next 15 years, she would have about $1.78 million. Not bad. If Denise only contributed the max of $24,500, she'd have about $1.58 million. Still not a bad amount of money, but it's a $200,000 difference roughly. So if you want to play with some of these numbers yourself, check out NerdWallet's investment calculator. We will link to that in the show description.
- [29:43]
B
And I just have to say $200,000 is not small money. I can think of 10 million or maybe 200,000 things I would do with $200,000 without traumatic now while all of this math sounds lovely, thank you for doing that Mr. CFP. We do have to point out that not every employer sponsored retirement plan offers the Roth feature, but luckily there are still ways for Those who are 50 and older to boost their retirement savings. Now one thing you all can do is put catch up contributions into an IRA instead. You can't save as much as you would with a 4. The annual contribution limit for an IRA in 2026 is $7,500 and then you get $1,100 in catch up contributions. And Roth IRAs are subject to income level restrictions. But something's better than nothing.
- [30:29]
C
Although if your income is too high to contribute to a Roth ira, you could explore a backdoor Roth ira. That's a strategy where you contribute non deductible funds into a traditional IRA and then convert them to a Roth ira. There's often a tax bill involved, so just be prepared for that. But you could potentially put $8,600 of non deductible dollars into a traditional IRA. That includes the standard limit and the catch up two. Then convert that to a Roth. But beware of the pro rata rule. We won't go too far down this rabbit hole because it's really technical, but you could potentially be on the hook for even more in taxes or a taxable that you just weren't expecting if you didn't look into this rule beforehand, that's it.
- [31:09]
B
It can get really complicated. So you want to seek financial advice before you do that. All right, Sean, so I just want to know what your thoughts are on this new rule.
- [31:19]
C
I think it's a great way for the government to get their taxes now instead of later.
- [31:25]
B
I agree, but I have a little rant. I don't know. I think it's a strange rule. It's a strange rule because when you think about it, people who are 50 and older are hopefully in their highest earning years and then it's like they're being penalized after working all these years to get to that point of high earner by losing the tax break. And I think these tax breaks can be helpful because they lower your taxable income, if that's something that you want to do. And then my other thought is that retirees and seniors as a whole tend to be vulnerable. And I think they should be able to get that tax break if they need it so they have a better chance at a comfortable retirement. We know so many retirees aren't comfortable right now, you know, because they didn't save enough or life happened and so on and so forth. But like you said, Sean, I get that the government needs their tax dollars, but I'm not going to go into my thoughts on how those tax dollars are being used.
- [32:11]
C
We can talk about that another time. But I think this all goes to show that the priority here wasn't maybe giving people an option to save as much as they could for retirement. It was really about the government getting their money now versus later.
- [32:24]
B
Oh, I think it's a good note to end the episode.
- [32:27]
C
That's all we have for this episode. Remember, listener, that we're here to answer your money questions. So turn to the nerds and call or text us your questions at 901-730-6373. That's 901-730. N E R D. You can also email us@podcastnerdwallet.com we would love, love, love.
- [32:45]
B
If you would join us next time to hear about climate change and the financial impacts of home ownership. Useful episode if you are planning to buy a house or own one. In the meantime, follow Smart Money on your favorite podcast app, that is Spotify, Apple Podcasts and iHeartRadio to automatically download new episodes.
- [33:03]
C
Here's our brief. We are not your financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.
- [33:12]
B
This episode was produced by Tess Figland, Hilary Georgie help with editing, Nick Karisimi and Eve Krogman Helmar audio and video production and a big thank you to NerdWallet's editors for all their help.
- [33:24]
C
And with that said, until next time, turn to the nerds.
- [33:33]
E
Tech moves fast, so keep pace with the Daily Crunch podcast from TechCrunch. With new episodes every day, this podcast will give you a quick overview on everything you need and should know about startups, new tech regulations, and more. Listen to TechCrunch Daily Crunch now. Wherever you get your podcast, that's TechCrunch Daily Crunch. Wherever you get your podcasts.