Investing Basics The power of diversification

Nothing is ever certain in investing. There are some investment principles, though, that tend to hold true in many environments. For example, if you want higher returns, the trade-off is usually accepting more risk and volatility.

Another important investment principle is the concept of diversification. We’ve all heard the adage of not putting all your eggs in one basket.

But how can we really know that diversification is actually powerful? And how can it help individual investors in today’s markets?

While diversification may help smooth a portfolio’s fluctuations, it does not eliminate risk. In other words, diversification may not protect you from a loss when markets are falling.

At the portfolio level, diversification is based on owning a mix of asset classes, such as stocks, bonds, and alternative investments like private credit and commodities. This article will focus specifically on diversification in stocks, or equities.

Overall, we think it’s helpful for investors to think about diversification in equities on three different levels:

• Stock concentration
• Sectors
• Themes

Rising stock concentration

When it comes to diversification, stock concentration is the elephant in the room. We’re talking about the Magnificent 7¹, of course.

In recent years, a handful of mega-cap companies have dominated index performance, significantly influencing overall returns. For example, the S&P 500® Index has nearly 39% in its top 10 constituents.² Invesco QQQ ETF, which tracks the Nasdaq-100® Index, has about 53% in its top 10 holdings.³

Yet these indexes are simply doing their job because their methodologies weight individual stocks by size, as measured by market capitalization.

One reason leading stocks like Nvidia, Microsoft, Apple, and Amazon.com are massive is because they’re so entrenched in our everyday lives. Their positioning could potentially be attributed to their profit margins and cash flows, relative to their competitors.⁴ Therefore, it could be argued that the recent dominance of the market’s largest stocks is justified by their strong fundamentals and investor confidence in their prospects.

A key takeaway is to remember that some popular market benchmarks are currently top-heavy by historical standards, so they may not be as diversified as investors assume.⁵ Also, like many other factors in the market, concentration levels tend to vary over time. For example, there was an extended period during the 1950s and 1960s when the market was similarly concentrated in the top 10 stocks like today.⁶

Tech leadership

Another topic that’s been top of mind for many investors in recent years is the strength of Technology stocks, leading some to question the wisdom of diversifying into other sectors.

In fact, since 2017, Technology has been the top-performing U.S. sector in half of the years (four out of eight years). But notice what happened in the other four years: Energy dominated twice, while Health Care and Telecommunications each led once. No sector has maintained permanent leadership.

So, unless you have a crystal ball, investing in a variety of sectors may help you weather the ups and downs of individual industries.

Granted, QQQ has 64.03% of its portfolio in the top-performing Technology sector.⁷ While Technology has comprised a significant portion of QQQ’s portfolio, it has also allocated to sectors such as Consumer Discretionary, Health Care, and Industrials. Other sectors that QQQ may hold include Telecommunications, Consumer Staples, Basic Materials, Utilities, Energy, and Real Estate.

Innovation across themes

Diversification isn’t only about owning stocks across multiple sectors—it can also be about participating in different innovation themes that are shaping the economy. While Technology companies often lead the way, QQQ’s holdings reflect how innovation now extends across nearly every sector.

• Artificial intelligence (AI): The AI transformation has moved beyond hype to widespread adoption, reshaping business models in software, cloud computing, and hardware. Leaders such as Nvidia, Microsoft, and Alphabet are driving the buildout of AI infrastructure—from chips and data centers to productivity software—supporting a wave of enterprise and consumer applications across industries.
• Health care and life sciences: In Health Care, innovation continues in robotic surgery, precision medicine, and AI-assisted drug discovery, to name a few. Companies like Intuitive Surgical, Amgen, and Vertex Pharmaceuticals are blending technology with biology to enhance patient outcomes and accelerate research breakthroughs.
• Semiconductors and advanced manufacturing: The world’s demand for computing power has made semiconductors a strategic cornerstone of the modern economy. Within QQQ, firms such as Nvidia, AMD, Broadcom, and Intel are helping expand global chip capacity and develop the next generation of processors driving everything from smartphones to AI supercomputers.
• Digital platforms and media: As the digital economy matures, companies like Apple, Amazon, and Netflix continue to innovate through AI-driven personalization, cloud-based delivery, and new forms of entertainment. These efforts highlight how creativity, data, and technology converge to shape consumer experiences worldwide.

Together, these examples show how innovation diversification can complement traditional sector diversification—helping investors gain exposure to multiple sources of potential growth that often move on different cycles.

Key takeaways

• Major market indexes recently had high historical concentration in their top holdings, which may affect equity diversification.
• Sector leadership rotates over time, with no single sector consistently outperforming year after year.
• Diversification spans different asset classes, and within stocks it may include both traditional sectors and emerging innovation themes across the economy.