Are Index Funds Still Diversified? Concentration Risk and a Top-Heavy Market
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If you're 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 Piles.
And I'm Elizabeth Iola. Later this episode, we'll be discussing catch up contributions and how to fund accounts for 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, Anna Hilchowski, 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. Anna, welcome back.
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 it very much. But index funds aren't as spread out as they once were. And that's because a small group of companies now make up the biggest slice in 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.
Yeah, thanks for having me.
So from my understanding, concentration risk is when a handful of companies are basically running the stock market. Is that an oversimplification?
Yeah, I think it is a slight oversimplification. I mean, 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 bond 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.
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