S&P 500 index investors have been rewarded so far in 2025. Why experts say it may be time to diversify

Core Viewpoint - The S&P 500 index has rebounded from its April lows, but experts caution that investors should be aware of the risks associated with a concentrated investment strategy in large-cap stocks, as the index represents about 80% of market capitalization [1]. Investment Strategy Insights - Morgan Stanley's chief investment officer, Lisa Shalett, advises against a "set-it-and-forget-it" strategy focused solely on the S&P 500 for short-term performance evaluations, although long-term index investing remains valid [2]. - Many investors tend to frequently check their accounts, which contradicts the long-term investment approach that the S&P 500 strategy suggests [3]. Market Dynamics - The S&P 500's recent performance has been driven significantly by a few technology stocks, referred to as the "Magnificent Seven," which contributed 26% of the earnings growth, while 493 companies only saw a 3% profit growth [4]. - This concentration in a few stocks indicates a narrow market, which raises concerns about overall market health [5]. Changes in Index Composition - The top 10 holdings in the S&P 500 now account for approximately 40% of the index, with a strong emphasis on technology and AI [7]. - The only exception among the top 10 is Berkshire Hathaway, which is not tech or AI-related [8]. Generative AI Opportunities - The potential for generative AI in the market is still being realized, with Morgan Stanley identifying untapped opportunities in sectors like business services, financials, and healthcare [9]. - Berkshire Hathaway's recent $1.6 billion investment in UnitedHealth reflects confidence in the transformative potential of generative AI in the insurance industry [10]. Diversification Strategies - Investors holding S&P 500 or ETFs concentrated in large-cap stocks may need to rebalance their portfolios, as concentration has increased due to the outperformance of these companies [11]. - Morgan Stanley recommends diversifying into smaller stocks, international markets, and emerging markets, as well as considering an equal-weight index for the S&P 500 to achieve better diversification [12][13].