Passive Investing Is an Active Bet

When talking about investing, the word "passive" carries a lot of connotation. It suggests an absence of decision-making, and the advertised outcome to an absence of decisions is fewer mistakes and lower risk.

However, deciding to put your money into a particular index fund is itself a decision. While some major index funds have historically been lower risk than many other investment vehicles, the risks inherent to the approach should be understood by those who decide to invest that way.

Index investing is one of the greatest financial innovations of all time, and the S&P 500 has outperformed almost any other mainstream approach to holding equities. Index investing has undeniably been a good thing, but that doesn't mean it is risk-free. And as index investing becomes more and more prevalent, it is worth asking the question of whether the sheer size of the investments introduces new risks.

Understanding the S&P 500 index composition

State Street publishes the full holdings of its S&P 500 fund every day.¹ Taking the file dated 25 August 2026 and adding up the weights:

The largest holding, Nvidia, is 7.8 percent of the index on its own.
The top ten holdings are 37.1 percent.
24 companies account for half of it.
There are 505 lines in the file, representing 502 companies.

If we collapse the dual share classes so that Alphabet counts once, the top ten companies are 38.6 percent and the top five are 29.6 percent.

Three of the top ten are semiconductor companies. Nvidia, Broadcom and Micron together are 11.9 percent of the index, and several of their largest customers are also in the top ten.

Percentages of the top ten are easy to quote and hard to feel. A better measure is the Herfindahl index: square every weight, add them up, take the reciprocal. The result is the number of equally weighted stocks that would give you the same concentration.

For the S&P 500 on 25 August 2026 that number is 47.8. At the company level, combining share classes, it is 44.6.

So a fund holding 502 companies is, in concentration terms, behaving like a portfolio of about 45 equally weighted ones. The asset manager GMO put the same measure at 59 at the end of 2023, and noted that a decade before that the index had been more than twice as diversified, at around 118.⁷

That is the number worth sitting with. Effective diversification has fallen by roughly 60 percent in thirteen years, and by GMO's account no ten-year stretch since their series begins in 1957 has moved this far in either direction.

Did passive investing cause this concentration?

It's hard to answer this definitively, but let's dig in to some of the research around the topic.

The mechanism is plausible and measured. Gabaix and Koijen's inelastic markets work estimates that a dollar flowing into the stock market raises aggregate market value by about five dollars, with a range of three to eight across specifications.³ Demand for equities is far less elastic than the textbook assumes, so flows move prices rather than being absorbed by willing sellers. In a nutshell: more money flowing to a stock causes an outsized increase in the price of that stock, and as more people are focused on index stocks such as those in the S&P 500, the inbound flow has an outsized effect.

The size effect is documented. Jiang, Vayanos and Zheng, published in the Review of Financial Studies in December 2025, find that flows into passive funds "raise disproportionately the stock prices of the economy's largest firms, and especially those large firms that the market overvalues."² Their mechanism is that passive flows raise the idiosyncratic volatility of those firms, which makes arbitraging the mispricing riskier, which in turn discourages the correction. A striking implication: the aggregate market can rise even when every dollar of flow is investors switching from active funds to passive ones.

Passive ownership is larger than often stated. Chinco and Sammon argue the passive-ownership share is roughly double the commonly cited figure, because the standard number counts index funds and ignores institutions running index portfolios internally and active managers who are indexing in all but name. Where the conventional estimate for 2021 was about 16 percent, they put it near 33.5 percent.⁴

Would stock prices look like this anyway?

Some have argued that the fundamentals of the largest companies in the S&P 500 mean they would have arrived there anyway.

Guinness Global Investors researched this in July 2026 and the finding doesn't support the passive-distortion thesis. The top ten companies now generate about one third of the entire index's net income, roughly double their 2015–16 share. Market value share and profit share have risen broadly in step. Since December 2023 the market value share has only edged slightly ahead of the earnings share, and the price-to-earnings premium of the top ten over the rest of the index has barely moved.⁶

In other words, the top ten did not get expensive relative to everyone else. They got large because they got profitable, and the index mechanically followed. That is cap weighting doing exactly what it is supposed to.

Two qualifications keep the debate going. Earnings growth contribution from the top ten has been falling, from around 70 percent in 2024 toward 50 percent in 2026, so the engine is decelerating even as the weights stay high. And a fundamentally justified weight and a flow-inflated one are not mutually exclusive: Jiang and coauthors' point is specifically about the marginal dollar, not about whether the underlying business is good.²

What changes?

Set aside the question of whether prices are wrong. Something else is happening that is easier to establish.

Sammon's work on price informativeness finds that the rise in passive ownership over the past thirty years has reduced the amount of information incorporated into prices ahead of earnings announcements, by about a quarter of its long-run average.⁵ This shows up in the size of the move on earnings day: if the market has already done the work, the announcement is close to a non-event, and if it has not, the price jumps. Across US equities the average absolute earnings-day move doubled over the period Sammon studies, from roughly 2 percent in 1990 to roughly 4 percent in 2019.

The mechanism proposed is rather simple: heavily index-owned stocks get less analyst attention, are traded less before announcements, carry more earnings uncertainty, and then react more when the news lands. Passive buyers don't have per-stock "skin in the game" so to speak, so they aren't buying or selling based on what they think will happen.

The second measurable shift is governance. Bebchuk and Hirst's work on the Big Three found that as of 2021, BlackRock and Vanguard alone held medians of 9.8 and 12.0 percent of votes cast at annual meetings, with the three largest index managers together at a median of 27.6 percent.⁸ If you own direct shares of the largest company in the world, you can vote and otherwise influence actions they take. When you own the company via an index, it is the company that manages the index that holds that influence. As a result, these passive investors are "hands-off" in the voting process.

The risk

When the risks of passive investing are discussed, one of the most common assertions is that if inflows lift prices with a multiplier of five, outflows should crush them by the same factor.³

As it turns out, this is the weakest-supported claim in the whole debate. The multiplier is estimated on the data we have observed, during an era of sustained net inflows into passive vehicles. There has never been a prolonged period of large net passive outflows to measure, so we just don't know what will happen.

To be clear, the risk hasn't been proven as wrong, it's just untested. Plainly put, we just don't know what will happen.

What this means for passive investing

None of the above is an argument against index funds. The fee difference is real and has a dramatic compounding effect on your money, and nothing here suggests a better place to put it.

The case for indexing is a case about costs and about the difficulty of doing better. And to be very clear, the case is exceptionally compelling. At the same time, there are risks, and as passive investing increases any actual risk will only grow.

Until we see a longer period of sustained outflows, the potential risks are largely theoretical. Be aware of the impact that a large and increasing amount of money associated with passive investing might have on the overall market, and consider the risks in your diversification strategy.

Sources

SPDR S&P 500 ETF Trust daily holdings (State Street). Every concentration figure above is computed from this file, dated 25 August 2026.
Passive Investing and the Rise of Mega-Firms (Jiang, Vayanos and Zheng; Review of Financial Studies, December 2025). The size-dependent price effect, and the mechanism through idiosyncratic volatility.
In Search of the Origins of Financial Fluctuations: The Inelastic Markets Hypothesis (Gabaix and Koijen). The multiplier of roughly five.
The Passive-Ownership Share Is Double What You Think It Is (Chinco and Sammon). Why the headline passive share understates the real one.
Passive Ownership and Price Informativeness (Sammon). The decline in pre-announcement information, and the analyst-attention mechanism.
Rising S&P 500 concentration was rational (Guinness Global Investors, July 2026). The earnings case against the distortion thesis, and the evidence that the growth contribution is fading.
Magnificently Concentrated (Inker and Pease, GMO). The effective-stock-count framing, and the long-run record of the largest ten.
Index Funds and the Future of Corporate Governance (Bebchuk and Hirst, Columbia Law Review). The voting concentration figures.