Stock markets are unfair; a few companies are responsible for most of the returns.
This might seem chaotic, but it’s just how things work.
What Do You Mean By Concentration?
Imagine discovering that only 3.4% of all companies in the stock market have created all the wealth since 1926. This may seem unfair, but research shows that it is true. Professor Hendrik Bessembinder found that just 966 firms (3.4% of the total) generated all the net wealth in the U.S. stock market, and only 120 companies (0.43%) were responsible for 60% of that wealth [1] [2].
Additionally, a recent report from Morgan Stanley highlights that the top 10 companies in the S&P 500 now account for about 27% of the market’s total value, up from roughly 14% ten years ago [3]. Simply put, a few large companies dominate the market while many others lag.
Is it something I should be worried about?
Before you start panicking about diversification, here’s a nugget of wisdom: return concentration isn’t a flaw in the system—it’s a natural outcome of how returns work. Any stock’s potential upside is limitless, whereas the worst you can do is lose everything. That means a few runaway winners can and do more than makeup for the myriad losers.
Take a moment to think about it: if you invested in every stock in the market, you wouldn’t be ruined by the dozens (or hundreds) that underperform. The magic lies in those superstar stocks that deliver astronomical returns—like NVIDIA’s jaw-dropping 171% gain in 2024, which alone accounted for 22% of the S&P 500’s return that year.
What should I do?
Here’s where it gets interesting: while active managers worry about finding the few best companies to invest in, index (passive) investors focus on owning all of them. If you’re trying to pick winning stocks, you’re facing a tough challenge because the system rewards only a small number of them. Active managers have a difficult job. If they miss just a few top performers, their results can look much worse. The evidence shows that as the market becomes more concentrated, it gets harder to outperform a broad index such as the FTSE 100.
What does this mean for me?
If you’re an investor deciding between going after high-flying stocks or taking a broad-market approach, here’s the straightforward truth:
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Indexing isn’t a fallback—it’s a smart strategy. You’re not trying to outperform the market; you’re accepting its natural tendencies and allowing the top performers to thrive.
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Don’t worry about the underperformers. Most stocks can be poor investments, but by holding a diversified index, you’ll naturally benefit from the few big winners.
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Keep it simple. While academic discussions can be detailed, the key message is that owning the whole market is your best option if you can’t identify the top performers.
Looking Ahead
The stock market is changing due to technology, artificial intelligence, and new business models. In the future, today’s top mega-cap stocks could be replaced by new innovators. Whether you’re actively managing your investments or just starting, it’s essential to be open-minded, keep learning, and believe in the long-term benefits of diversification. Remember, the best-performing companies will change over time, but a diverse index prepares you for new opportunities. You don’t have to worry about missing out on top performers; they are already part of your investments.
In short, stock market concentration is a feature of today’s financial landscape. It may look intimidating, but research shows it’s not something to lose sleep over, especially if you’ve already started investing.
If you’re tired of people who are against indexing and want a straightforward way to invest, remember: it’s not about chasing every top performer—it’s about owning the entire group. Here’s to smart investing!
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[1] Bessembinder, H. (2023). Shareholder Wealth Enhancement, 1926 to 2022. Available at SSRN: https://ssrn.com/abstract=4448099
[2] Bessembinder, H. (2024). Which U.S. Stocks Generated the Highest Long-Term Returns? Available at SSRN: https://ssrn.com/abstract=4897069
[3] Mauboussin, M. J., & Callahan, D. (2024). Stock Market Concentration: How Much Is Too Much? Morgan Stanley
