In early 2025, a sharp decline in AI stocks presented a cautionary tale to investors about the dangers of concentration risk. That’s the threat of outsized losses an investor can suffer if they have a large part of their holdings in a particular investment, asset class or market segment.

In fairness, sometimes the outsized losses do come on the heels of outsized gains, but it can still hurt an investor’s psyche.

Other times, there are investors who remain intentionally concentrated in certain companies because of either a high risk tolerance or unwillingness to pay taxes on a stock sale if they hold the shares in a non-qualified account.

For the latter, there are often answers to address that tax issue, but that’s for another day and article.

As an example of the risks of overconcentration, look at what happened to Nvidia (NVDA) on January 27, 2025. This AI leader and seemingly unstoppable force was severely impacted by the drop in AI stocks, and the company’s shares fell about 17%.

Sometimes, a disruptive new company can cause the value of established businesses to drop like a rock, which is what happened to Nvidia when China announced it had released an AI competitor called DeepSeek.

Sometimes, a stock’s decline is caused by an unfounded or misunderstood story. Regardless, it should bring about some sober caution.

Do you know how exposed you are to such a scenario? And if you are heavily invested in one company or a handful of companies, are you OK with a day like January 27 for Nvidia and AI stocks?

Ignorance isn’t bliss for investors

It may surprise you, but many people don’t know what they own in terms of investments, nor how much they own.

Folks often come to us to discuss their investments — stocks, mutual funds, exchange-traded funds (ETFs), 401(k)s or retirement plans, Roth IRAs, etc. — but they have no consolidated view that shows how much they own of various companies.

Take the Magnificent 7 stocks: Alphabet (Google’s parent company), Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla.

These well-known tech companies usually comprise about one-third of the weighting in the S&P 500 (it’s been nearly as high as 40% at one point in time), significantly influencing the performance of the broader market index.

They represent one-third of the total value of an index made up of 500 companies. If all 500 companies were equally weighted, each one would be just 1.4% of the total, which also means many are not even a small fraction of a percent of what someone owns.

That’s overdiversification, which is a topic for another day, but it is possible to have concentration and overdiversification at the same time.

People are usually invested across these companies through numerous ETFs and mutual funds. We often find many people have at least 10% in Apple and 10% in Nvidia without knowing it.

That approach has worked well in recent years, but it doesn’t always. Plus, it’s not necessarily sound investing in terms of reasonable diversification.

Investors should ask these seven questions:

• Do I know what I own?
• Do I know how much of it I own?
• Do I know why I own it?
• Do I know how expensive it is?
• Do I know if it is a financially healthy and quality company with the prospects to generate long-term growth?
• What are the risks that I face with it?
• Do I even want to own it?

Setting and forgetting may bring regrets

You need to decide what kind of an investor you are.

Do you just invest in an index and let it ride — i.e., “set it and forget it”? Many people are generally asleep at the wheel in the sense that they just put their money into a mutual fund or ETF and turn their mind off.

Typically, they’re dedicated, methodical savers with a 401(k), and they’ve gone into the menu of options but don’t look to see what is in each of those funds. They’re mainly looking at stock vs bond allocation.

This can be beneficial in a wealth accumulation stage, but perhaps not so much in a wealth decumulation phase (retirement).

Are you just going with the market, not paying attention to what you own or managing risk with a balance of cash, bonds and other safe money?

You can do that — or you could also investigate the seven questions above.

Exploring risk

Let’s look at the risk question and use Nvidia as an example. People jumped aboard the AI investing train and acted as though Nvidia is the only game in town; their thinking was to own as much of it as possible and let it run, which works until it doesn’t.

But if you really think about it, in these heady days of the technology arms race, it’s probably not reasonable to think Nvidia is going to be unrivaled, or there’s not going to be competition eager to take market share.

There will be rivals threatening to take market share, but who and when isn’t always known or obvious.

The result of having such blinders on blindsided some Nvidia stockholders on Jan. 27. The DeepSeek effect on AI stocks was an example that can apply to every company and industry.

Over the previous weekend, Nvidia had been trading near all-time highs, and then it was down 17% in a day. If 10% or more of your money was in that stock, that’s scary.

Of course, it felt good while it was going up, but it can get nerve-wracking when you have so much riding on one company.

Bottom line, you should ask yourself: Am I OK having 10% or more of my money invested in one company? If you intend to concentrate your money in this way, then fine. If you don’t, then you should know and consider what you might do about it.

Broadening diversification across industries to reduce risk

Warren Buffett once said: “It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

There are a lot of wonderful companies, but they’re not necessarily at a fair price right now. Many people have a third or more of their money in the Magnificent 7.

But they also have exposure to over 1,000 companies because many ETFs include companies that most people have no idea who they are or what they do. What these investors have is a heavy concentration in the Magnificent 7 combined with overdiversification.

Another approach is to build a balanced portfolio with a group of wonderful companies at fair or reasonable prices and allow a reasonable time for each to do what they do for the long term, lessening the concentration risk.

Nvidia’s sudden and sharp plummet in early 2025 is an example of why a reasonably diversified portfolio makes sense, and moreover, why it should be diversified across industries.

If someone diversifies away from Nvidia and then just owns a bunch of other AI-oriented companies, that’s not diversification either.

Is it fairly priced?

Price-to-earnings, discounted cash flow and fair value are just a few valuation metrics investors can use to value a company. As investors, we’re all invested in a story — one that will be revealed in the future of a company or group of companies and the expectations orprojections of those companies to grow.

Otherwise, we’d all just pay book value for acompany (the value of its assets less its liabilities).

When you look at the collection of the different constituents in a portfolio, you should ask, “Am I overall fairly valued, undervalued or overvalued?”

The Shiller P/E ratio (or PE10) is a methodology that tries to smooth out the imperfections in valuation that can be heavily affected by the current conditions. It’s basically taking the current price divided by the last 10 years of earnings.

In contrast, the P/E ratio is taking the current price divided by either the last 12 months of earnings or the next 12 months of earnings. When times are good, the P/E ratio looks reasonable.

At the risk of oversimplification, when you think about how people make money on stocks, it’s kind of like real estate — when you buy at the right price, you’re buying low. But people don’t think about that.

People who bought real estate in 2009 or 2010, after valuations were heavily damaged, have made good money since then. But people who bought real estate in 2007 on the belief that it was going to continue to rise in price got clobbered.

This example is a reminder that when valuations are high, the earnings have to keep coming and growing to support the valuations. When they stop, all the air is let out of the balloon.

Know your upside and downside

Valuations for just about everything, especially the Magnificent 7 and many of the AI stocks, are priced for everything to keep rolling and growing.

But if there’s an economic pullback or some geopolitical event, stocks will be affected.

Reasonable diversification is not just about knowing how much of each company you own, but also which industries and asset classes you’re in so that you know what your upside and downside are.

Know what you own, how much you have invested in it, and whether you’re OK with the risks you’re taking.

Dan Dunkin contributed to this article.

Appearances on Kiplinger.com were obtained through a paid public relations program. The author received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

Some media features/appearances mentioned in Scott Noble’s biography are advertisements paid for by Boomfish Wealth Group, LLC to promote the business.

The information contained herein is for educational purposes only. It is not intended to provide, and should not be relied on for, any tax, legal or investment advice. You are advised to seek the advice of a qualified professional prior to making any decision based on any specific information contained herein. The specific tax consequences of any investment or strategy will depend on your specific tax situation.

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