During recent client review meetings, I’ve noticed two concerns coming up regularly.
The first is the growing dominance of large US technology companies and whether current valuations can continue rising.
The second is rising government debt levels around the world, particularly in the United States and Australia, and whether governments are willing or able to address these issues over the long term.
While nobody knows exactly what happens next, these discussions highlight an important question:
Do you really understand what’s driving the returns in your portfolio?
For more than a decade, investors have enjoyed one of the strongest bull markets in history. Much of that growth has been driven by a relatively small group of US technology companies.
Nvidia, Microsoft, Apple, Amazon, Meta, Alphabet and Tesla, commonly known as the Magnificent Seven, now make up approximately one-third of the S&P 500 Index. These are exceptional businesses, but their size means many investors have more exposure to them than they realise.
The Hidden Concentration Risk
Many Australians believe they are diversified because they invest through a large super fund or a broad market index option.
However, market-capitalisation indices allocate more money to larger companies. As those companies grow, investor exposure automatically increases.
Most super fund members can see their balance, returns and investment option. Far fewer can identify their actual exposure to specific companies, sectors or investment themes.
As a result, portfolios that appear diversified may still be heavily reliant on a small number of businesses continuing to perform.
Could Technology Be Overvalued?
Nobody can predict when markets will rise or fall.
Importantly, today’s technology leaders are highly profitable businesses, unlike many of the speculative companies seen during the dot-com era.
Even so, investors should ask sensible questions:
- Have expectations become too optimistic?
- Will AI investment generate sufficient returns?
- Can earnings growth continue to justify current valuations?
- What happens if investors become less willing to pay premium prices for growth?
At the same time, many investors are questioning whether rising government debt and years of fiscal stimulus have contributed to higher asset prices. Whether these concerns prove justified or not, they reinforce the importance of diversification.
What If Technology Shares Fell?
A significant correction in large technology companies would likely have broader market impacts, including:
- Lower share market returns
- Reduced super balances
- Increased volatility
- Lower investor confidence
The biggest risk is often behavioural. Investors who become accustomed to strong returns can find it difficult to stay invested during periods of market stress.
Why Diversification Matters
Bull markets can make investing look easy.
Bear markets remind investors why diversification matters.
A well-constructed portfolio should not rely on a single sector, country or investment trend. Diversification may include Australian shares, international shares, fixed interest, cash, alternative investments and active asset allocation strategies.
The goal is not to avoid all losses. The goal is to reduce reliance on any one market outcome.
Questions Every Investor Should Ask
Rather than trying to predict the next correction, investors may be better served by asking:
- How much exposure do I have to the Magnificent Seven?
- What would happen if they fell 30% or more?
- How diversified is my portfolio really?
- Where is my downside protection?
- Who is monitoring portfolio risks on my behalf?
The Bottom Line
The objective isn’t to predict a market crash or technology correction. Nobody can do that consistently.
The objective is to understand the risks being taken to generate returns and ensure your portfolio is positioned to navigate different market environments.
Technology shares may continue to perform strongly for many years. Equally, future returns may be lower than investors have become accustomed to.
Either way, investors should understand what they own, where the risks lie and whether their portfolio is truly diversified.
Because when markets are rising, everyone talks about returns.
When markets fall, investors ask a different question:
“Do I really know what I own?”
