Market concentration results when there is a disproportionate amount of price appreciation spread over a small amount of stocks.
Let’s back up a bit, shall we?
Many investors have their money in index funds, which follow a particular type of market index. The index may be weighted according to the market capitalization of each stock. In those cases, if the market is concentrated, the investors now hold a higher amount of those few stocks that have run up. The stocks that have run up now comprise a higher percentage of your total investment in the index.
Why does market concentration matter?
It can cause volatility in your portfolio, because now you hold a higher percentage of a small amount of stocks. The ups and downs of the stocks where you have a concentration will have more impact on the performance of the index fund you hold.
An example of market concentration is the Magnificent Seven: Meta, Google, Amazon, Microsoft, Apple, TSLA, and Nvidia. These stocks now have a combined market capitalization of $21 trillion, according to US News, which is hugely disproportionate to that of the rest of the market.
The opposite of market concentration is market dispersion. During times when the market is widely dispersed, there is a lot more balance amongst holdings, and the bigger companies don’t have as much of an impact on the index’s performance.
The good news is that this is normal. Historically, the market has gone through times of high concentration alternating with high dispersion. Trying to time it is futile. The best strategy for managing market concentration is to have an eye towards the overall diversity of your portfolio, and know what you hold at all times.
It also makes sense to be a long term investor and stay the course over time. Trading for short term price movements is not a good idea. It’s best to gauge your risk tolerance and goals, and create a portfolio that is designed to help you potentially achieve those goals in the long term.
As always, please set up a time to speak if you’d like to discuss.
-Judd
Sources
Duggan, Wayne. (21 May, 2024). US News. Magnificent 7 Stocks: What Are They and How They Dominate the Market. https://money.usnews.com/investing/articles/magnificent-7-stocks-explainer