“I don’t take a lot of risk with my investments. I just buy index funds.” I’ve heard versions of this comment on many occasions, and it makes me nervous.
Don’t get me wrong, I am all for index investing, and I’m not just saying that because I work for Morningstar’s index group. The low fees that most index funds carry constitute an advantage, and Morningstar research consistently shows that most active managers don’t outperform their index-tracking counterparts.
But failing to capture the full return of the market is just one kind of risk—there’s also volatility of returns and susceptibility to losses. In those regards, an index fund focused on a niche like cannabis stocks, semiconductors, or catastrophe bonds can be very risky.
Big, broad market indexes carry risks as well. US stock index funds shed nearly 40% of their value between 2000 and 2002, then again in 2008. Bond index funds declined by 13% in 2022.I’m not suggesting similar crashes are imminent, just that index funds carry risk.
Here are three risks index fund investors face today.
I’ve written about this a lot lately, but it bears repeating: The US stock market is concentrated and high-priced. Here’s how the Morningstar US Total Market Index has evolved over the past 15 years on three parameters: concentration in the top 10 constituents, exposure to the
technology
sector, and price/earnings
.
When Apple AAPL and Amazon.com AMZN reached $1 trillion market capitalizations in 2018, some saw it as a sign of froth. Since then, the rich have only gotten richer. In 2020, market share for the top 10 US stocks crossed the 20% threshold last seen during the 1990s technology, media, and telecom bubble. Then, in 2025, concentration breached 1932 levels.
Approaching 2026’s fourth quarter, nine US stocks claim $1 trillion market caps, including Nvidia NVDA at $5 trillion. “A historically concentrated market isn’t necessarily bad,” I wrote at the start of the year, “but it does pose risks.” Today’s market is highly dependent on a small number of behemoths, such as Nvidia at nearly 7% of index weight.
The market is also highly concentrated by sector and industry. Technology stocks represent more than one-third of US market value. As my colleague Tom Lauricella recently pointed out, semiconductor makers specifically have come to dominate. The semiconductors industry now rivals railroad stocks in the 1920s in terms of US market share.
From a valuation standpoint, today’s market is pricey, though below 2020-21 levels. The market’s price/earnings ratio hit 28.0 then, on a trailing 12-month basis, versus 24.3 at the end of August. That’s still high by historical standards, though; earnings growth is closely tied to corporate spending on artificial intelligence. It should also be noted that high prices five years ago preceded a painful correction in 2022.
The knock on bond indexes is that they reward the most indebted. That’s in contrast to stock benchmarks, in which winners get the most weight. When it comes to indebtedness, no one beats the US government. That’s why the share of Treasuries in the Morningstar US Core Bond Index, which includes fixed-rate, investment-grade, US-dollar-denominated securities with maturities greater than one year, has been climbing steadily higher.
As you’ve probably heard, the US government debt burden recently passed the staggering milestone of $40 trillion—a debt/GDP ratio of 120%. “The level of the debt is not unsustainable,” former Federal Reserve Chair Jerome Powell said in March, “but the path is not sustainable.” Even if doomsday scenarios in which foreign holders dump US debt are unlikely, inflation and dollar weakness are real fears.
Bond yields have risen in 2026 for several reasons. Selloffs have hit not just US government debt, but other heavily indebted developed markets, such as the UK and Japan. Given the share of Treasuries, it’s unsurprising that the US Core Bond Index is in slightly negative territory for the year to date.
The plus side is that yields have climbed; the US Core Bond Index yielded roughly 5% as of the end of August. That’s comfortably above the inflation rate and far above stocks—but interest rates don’t look likely to fall anytime soon. And the growing share of Treasuries has left the bond market carrying heightened interest rate risk.
Two of the three risks I wrote about in relation to the US stock market are also true in emerging markets. Like its US counterpart, the Morningstar Emerging Markets Target Market Exposure Index also looks top-heavy and tech-heavy. It’s considerably less pricey, though, judged by index-level price/earnings.
When you drill down, stock-specific risk is even more extreme when it comes to emerging markets. Taiwan Semiconductor Manufacturing TSM alone accounted for more than 14% of the universe as of the end of August. Samsung Electronics 005930 and SK Hynix SKHY—also in the semiconductor space—added up to another 12%. As a result, “emerging market stock funds are now stuffed with artificial intelligence plays, just like many of their US-focused counterparts,” wrote Gregg Wolper of Morningstar’s manager research team.
AI has been a boon for emerging markets in 2026. But the asset class has become highly dependent on a single theme, in addition to the aforementioned single-stock risk. “To avoid getting waylaid by a single company’s misfortune, many funds keep individual stock positions to 5% of assets or less,” Wolper wrote.
What about lower prices for emerging-market stocks? Keep in mind, this is a sprawling universe. Beyond the AI stocks and certain popular markets like India, emerging markets spent more than a decade underperforming global equities. A collapse in commodity prices in 2014-15, a US-China trade war during President Donald Trump’s first term, China’s government crackdown on technology companies in 2020-21, Latin American political risk, and Russia’s invasion of Ukraine in 2022 have all weighed on valuations.
“Get out of the timing business,” wrote Morningstar’s Christine Benz in a recent article about investors’ understandable temptation to get tactical in fixed income. She notes that even professional investors get timing wrong. That applies not just to interest rate bets and shifting from bonds to cash, but also stock market valuation calls. Concentration and valuation risk have been features of the US stock market for years—yet an investor would have foregone huge gains by bailing in, say, 2018.
One response to the index risks detailed above is to diversify. Bonds still hold diversification potential relative to stocks, and it’s possible to allocate to different fixed-income asset classes. Within the US market, small caps provide different exposures. Internationally, developed-market equities outside the US are far less concentrated and tech-heavy than emerging markets.
Even within these asset classes, there are options for concerned investors. I recently suggested five alternatives for US equities exposure, including value stocks, dividends, and equal weighting. Similar options exist for emerging-market stocks. When it comes to fixed income, I recommend a recent Morningstar article called Why Passive Investing Doesn’t Always Work for Bond Funds.
The author or authors do not own shares in any securities mentioned in this article.
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