Investors generally recognize that the US stock market is currently concentrated. As of June 2026, the ten largest securities in the Vanguard US Total Market Index ETF (VUN) account for 34% of its nearly 3,500 stocks. In other words, less than 0.3% of the index portfolio’s holdings represent 34% of its market value. How does the current degree of concentration compare to historical levels? Does high market concentration predict poor future returns? Is the US market riskier now than in the past?
These questions are addressed in a recent Financial Analysts Journal article titled “The Fallacy of Concentration.”
Most people gauge market concentration by looking at the weight of the top ten, twenty, or twenty-five stocks. In their article, the authors use a more comprehensive measure of concentration called the effective number of stocks. This measure accounts for all the stocks in a portfolio, not just the largest ones. To understand how it works, let’s look at two hypothetical portfolios, each holding 100 stocks. Portfolio 1, which holds 99.9% of its value in its largest stock, would have an effective number of stocks of nearly 1, indicating that most of its value is concentrated in its largest holding. Portfolio 2, which has equal weights of 1% in each stock, would have an effective number of stocks of 100, indicating that its market value is evenly spread across all holdings.
The authors computed the effective number of stocks of the S&P 500 Index monthly since 1926. They found that the US market is near its most concentrated level ever, with an effective number of stocks of only 45. This means that the S&P 500 Index is equivalent to an equal-weighted portfolio of 45 stocks. However, this level of concentration is not unprecedented: similar levels were reached in 1926, 1957, and 1981.
To see whether high concentration predicts poor returns, the authors devised a dynamic trading rule that varies stock exposure inversely with concentration, the balance being invested in cash. Then, they compared the return of this “dynamic” portfolio with that of a constant-weight portfolio holding the same average percentage in stocks. Over time, both the US dynamic and constant-weight portfolios had an average stock weight of 67.8%. The authors also ran the test for UK, Japanese, German, Canadian, and Australian stocks. The constant-weight portfolio outperformed its dynamic counterpart in four of the six countries. In all cases, the constant-weight portfolio had lower or equal volatility than the dynamic portfolio. These results suggest that reducing stock exposure in response to higher concentration levels does not add value.
In another statistical test, the authors examined the relationship between concentration and several risk and return metrics in the US market, including cumulative return, volatility of daily returns, downside volatility, and maximum drawdown over 26 one-year periods. Concentration, as measured by the effective number of securities, failed to meaningfully explain variation in these metrics. Therefore, the market index is likely not riskier when more concentrated.
The fact that concentration does not predict future returns isn’t surprising: market-timing strategies are notorious for their poor outcomes. However, the fact that periods of higher concentration do not increase risk is more puzzling. The key to understanding this is the difference in risk between large and small stocks. For example, the authors report a standard deviation of 18.4% for the largest decile of US stocks, compared with 36.3% for the smallest decile. Small stocks are not only far more volatile than large ones, but also more dependent on a few top contributors (higher skewness) and more prone to extreme fluctuations (higher kurtosis).
A highly concentrated market has greater weight in less-volatile large-cap stocks, which offsets the negative effects of lower diversification.
Periods of higher market concentration do not predict poor future returns or increased risk. Market indices tend to be weighted heavily toward large businesses, which are, understandably, more stable than small ones. I do not think investors should worry too much about market concentration. The key is to hold the market portfolio. By doing so, you know in advance you’ll own all the best and worst future performers. On balance, historically, this portfolio has provided a decent return. However, if you are concerned about concentration, holding a significant weight in international markets—which are, as a whole, far less concentrated than the US market—may be a smart strategy.[1]
Lastly, investors should not take this research to mean that concentrated portfolios are acceptable. They are not. The article shows only that, within the market portfolio, periods of higher concentration are no riskier than others. A concentrated portfolio is something entirely different and carries uncompensated idiosyncratic risk.
[1] The MSCI EAFE IMI Index’s effective number of stocks is over 250 (Sources: iShares, PWL Capital).
