The S&P 500 has long been sold as an easy way for British investors to invest in top US stocks. The idea is simple: pick a decent S&P 500 tracker fund and you’re essentially invested in 500 major US companies — instant diversification.

But that may no longer be the reality. Nowadays, a tiny number of major corporations drive almost all of the index’s gains. So that ‘broad diversification’ is actually highly concentrated in one single sector: technology.

This isn’t just a technical detail. It affects risk, volatility, and ultimately the long-term potential of your entire portfolio.

So just how concentrated has the S&P 500 become?

The S&P 500 is market-cap-weighted, meaning bigger companies have more influence. When a handful of mega-cap technology firms surge, the entire index wins — even if the rest of the market is flat.

Lately, the top 10 companies have skyrocketed, capturing an increasingly large share of the index’s total market value. That means your ‘500-company’ investment is really concentrated in just a few tech giants.

For example, the Vanguard S&P 500 ETF holds 8.4% in Nvidia, 7% in Apple, 4.9% in Microsoft, 4.1% in Amazon and 3.6% in Alphabet. A further 11.3% in concentrated in the next five holdings.

That amounts to 39.3% of the total portfolio. For novice investors, this development should not be overlooked. The index might look strong, but its performance relies on the success of what could be a fragile foundation.

What does this mean for passive investors?

As said, most S&P 500 tracker funds are market-cap-weighted and therefore more exposed to this concentration risk. To limit this exposure, it’s worth considering an equal-weighted fund like the iShares S&P 500 Equal Weight ETF (LSE: ISPE).

This fund offers UK investors a way to reduce the S&P 500’s extreme mega-cap concentration risk by giving all 500+ stocks equal 0.2% weights.

The top 10 holdings represent just ~2.65% of the fund versus ~36% in a standard S&P 500 tracker, providing better diversification and reducing single-stock risk. 

The fund also offers a higher dividend yield of 1.89% versus 1.30%, adding attraction for income investors. Naturally, the equal spread means the fund often underperforms other S&P 500 trackers when US tech surges.

It’s also worth noting that the GBP-hedged version’s 0.17% ongoing cost is slightly higher than non-hedged alternatives. Meanwhile, it has quite a short track record and currency hedging adds cost that may erode returns over time.

So the trade-off’s simple: it’s at less risk if the bloated US tech sector takes a sharp dive, but more exposed to losses in other sectors.

Final thoughts

The S&P 500’s no longer just a simple, balanced bet on American business. Rather than 500 individual companies, it’s more like a few carefully-balanced companies wearing an S&P 500-branded trenchcoat.

If you understand that risk and still believe in the long-term direction of the US economy, the index can still be a smart core holding.

But if you’re chasing true diversification, you may want to look at equal-weight funds, sector-balanced portfolios, or global indices alongside the S&P 500.

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Mark Hartley does not hold any positions in the companies mentioned.