Despite the pandemic and global economic shutdown, the S&P 500 was flat on the year as of market close on June 8th, 2020. Since hitting the recent low on March 23rd, the index has rallied more than 45%. During this time, the five largest companies in the world (Apple, Microsoft, Amazon, Alphabet (Google), and Facebook) have grown more dominant, totaling 19% of the S&P 500 by the end of May. With the average U.S. investor increasingly exposed to mega-cap growth stocks, diversification is harder and more important than ever.

Particularly in light of ongoing government investigations and recent lawsuits, consider taking steps to help ensure big tech’s possible legal woes don’t become your financial problems.

Is big tech too big to fail?

Apple, Microsoft, Amazon, Alphabet (Google), and Facebook are the five biggest companies in the world by market capitalization. In January, these companies comprised about 11% of the value of the U.S. stock market, using the Russell 3000 as a proxy. By the end of May, they swelled to 17%.

The story isn’t new; these stocks have been an outsized driver of performance in the S&P 500 since 2015. It’s just much more dramatic in 2020. Between March 23rd and June 8th, Facebook’s stock increased over 56%. Amazon is up nearly 37% year-to-date.

Just as investors have benefitted from the concentration at the top, many could be over-exposed if there’s a reversal of fortune.

Big tech stocks outperform but lawsuits linger

 

Here are some staggering statistics (as of May 31st, 2020):

  • The five biggest companies represent 19% of the S&P 500 and 11% of the entire global equity market (based on the MSCI ACWI)
  • The Russell Top 50 largest U.S. stocks make up nearly half (46%) of the U.S. stock market
  • The smallest 2000 U.S. stocks are now only 6% of the domestic equity market

The growth of the largest companies since the Great Financial Crisis has been staggering. But that doesn’t mean it will continue forever. At the end of 2013, Exxon Mobil was 2.7% of the S&P 500—now the market cap has shrunk to .87%. In 2018, General Electric was delisted from the Dow Jones Industrial Average (DIJA) due to a shrinking stock price.

Legal issues linger for some of the biggest companies

The top five U.S. stocks have notoriously strong cash positions which has helped them navigate uncertainty. But not all financial problems stem from reduced sales. Regulatory changes and high-profile investigations into some of the world’s biggest companies continue to pose a threat.

The Wall Street Journal reports the Justice Department is moving forward with an antitrust lawsuit against Alphabet, the parent company of Google, as early as this summer. In March, Amazon was hit with a class action antitrust lawsuit alleging price fixing.

The stock market doesn’t always react as you’d expect to legal troubles, though. When details of the Facebook and Cambridge Analytica scandal were released, the stock would go on to sink 16% from previous highs. Yet when CEO Mark Zuckerberg testified in front of Congress, shares rose nearly 5%.

What all this could mean for these companies is unclear. But many investors may not realize how big price swings in a small handful of stocks could impact their account—even if they’re not buying single stocks.

Diversification is still the best armor

Deliberate diversification is still the best way to help insulate your investment portfolio against the major losses that can coincide with concentration risk. As the market capitalization of the S&P 500 grows on a global scale, this becomes more challenging.

When deciding on your investment strategy, consider diversifying your asset allocation between and within asset classes. For example, holding stocks and bonds will give you exposure to two different asset classes. But if you just buy a fund that tracks the S&P 500 and some 10-year treasuries, your investment mix is still limited to large-cap U.S. stocks and intermediate term government bonds.

Other factors to consider when diversifying are geography, market capitalization (e.g. small-cap or mid-cap), international developed or emerging economies, across sectors and industries, corporate and government bonds, and so on.

As the big guys get bigger, you’ll also want to consider the intersect between your ETF and mutual fund holdings. For example, if you own a tech stock ETF, a S&P 500 index fund, and a total stock market fund, the top holdings are most likely going to be the same across all three. This undermines the intent of diversifying.

Holding big tech names certainly paid off over the last few years. What returns look like going forward is impossible to predict. But as a larger share of the performance of the major indices are driven by the top five names, you should at least understand your exposure.

This article was written by Kristin McKenna, CFP®, Managing Director at Darrow Wealth Management and originally appeared on Forbes.

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