Magnificent 7 and concentration risk

Cus

If you invest in a market cap weighted index tracker, is it getting more and more risky having what effectively equates to 25% or more of your investment in 7 companies? 
I've read that most of 2023 S&P gains are concentrated in these 7 companies. Does that mean that it could actually be riskier to invest in a passive tracker versus an alternative fund that tries to minimise this?

Just wondering if the highly logical theories of passive tracker investing considered such concentrations?

InvesterJones

Cus said:

If you invest in a market cap weighted index tracker, is it getting more and more risky having what effectively equates to 25% or more of your investment in 7 companies? 
I've read that most of 2023 S&P gains are concentrated in these 7 companies. Does that mean that it could actually be riskier to invest in a passive tracker versus an alternative fund that tries to minimise this?

Just wondering if the highly logical theories of passive tracker investing considered such concentrations?

Depends if your view of risk is substantially different from the market's - value does take risk into account, but if you think you know better (or wish to tolerate less risk) than the market it's worth moving away from an index.

Cus

But is it more risky to have 25% of my money in 7 companies and 75% in 493 companies? Just because the 7 are judged to be worth more based on the current share price and therefore market cap, does that mean I should accept risk of my investment being influenced by just a few companies?  

Isn't it equally likely that Microsoft could have in value as any one of the 493 companies?

How do you get less risk whilst still investing passively?

wmb194

Cus said:

But is it more risky to have 25% of my money in 7 companies and 75% in 493 companies? Just because the 7 are judged to be worth more based on the current share price and therefore market cap, does that mean I should accept risk of my investment being influenced by just a few companies?  

Isn't it equally likely that Microsoft could have in value as any one of the 493 companies?

How do you get less risk whilst still investing passively?

You could look at equal weight ETFs.

https://www.investopedia.com/articles/exchangetradedfunds/08/market-equal-weight.asp

Albermarle

Cus said:

But is it more risky to have 25% of my money in 7 companies and 75% in 493 companies? Just because the 7 are judged to be worth more based on the current share price and therefore market cap, does that mean I should accept risk of my investment being influenced by just a few companies?  

Isn't it equally likely that Microsoft could have in value as any one of the 493 companies?

How do you get less risk whilst still investing passively?

I have some money in a tracker that tracks a global mid cap index. A lot of the companies in the index are actually quite large, but there no behemoths, like Apple, Microsoft etc 

However its recent performance has been rather poor. 9% over 3 years as compared to 22% for VWRL.

Cus

I just feel uncomfortable relying on 7 massive (and historically at very high P/E ratios) companies to control 25%% of the investment. It feels like an active decision to invest passively as you are making a call that those 7 will continue to perform at or better than the rest though I know that sounds odd.past performance is no guide to future etc etc
It feels like a reset is more and more likely.

Linton

It I think you are reading too much into the statistics.  A very large company is likely to generate a higher gain in £ terms than a small company simply because of its size. That doesn’t mean the large company is providing a higher % return. So for example not investing in the top 7 but investing more in smaller companies could give you a higher return than purely investing in the top 7.

masonic

Cus said:

I just feel uncomfortable relying on 7 massive (and historically at very high P/E ratios) companies to control 25%% of the investment. It feels like an active decision to invest passively as you are making a call that those 7 will continue to perform at or better than the rest though I know that sounds odd.past performance is no guide to future etc etc
It feels like a reset is more and more likely.

That can happen, yes, and you would harvest the market return despite this. Go back 20 or 30 years and look at what happened to the companies at the top of the index. The issue is that if avoiding the massive companies at the top of the index was known to be a winning strategy, then investors would avoid such companies, and their market cap would fall. So the majority of the money in the market is taking a different view. I'm currently underweighting the whole US market and overweighting ROW, though it hasn't done me much good so far. It's an active decision to disagree with market valuations at a particular time and change your approach accordingly, but that's ok. The passive approach is to go with the flow.

JohnWinder

I estimate it at 20%, not 25% of a global index, nonetheless your concern is valid but it’s all been discussed before, and seems not to be a harbinger of doom. https://www.bogleheads.org/forum/viewtopic.php?t=325194

I just feel uncomfortable relying on 7 massive (and historically at very high P/E ratios) companies to control 25%% of the investment.

Rather than risk ‘actively’ trading your way out of this discomfort you could simply hold more bonds.

jimjames

Cus said:

I just feel uncomfortable relying on 7 massive (and historically at very high P/E ratios) companies to control 25%% of the investment. It feels like an active decision to invest passively as you are making a call that those 7 will continue to perform at or better than the rest though 

If they do badly and another company takes their place then by holding a tracker you'll benefit from that gain as a result of holding that index tracker.

wmb194

Another option is not to invest passively.