The 17% drop in Nvidia's stock on January 27, erased over $590 billion in market value in a single day, as per reports. While the stock quickly bounced back, this dramatic sell-off provides a crucial reminder for investors about market risks, particularly the dangers of concentration, as per Motley Fool.

The risk of a top-heavy market

The decline in Nvidia and Broadcom reflects the risks of a market controlled by a few big players. According to the report, owning an index fund, such as the S&P 500 or Nasdaq-100, might feel diversified, but in reality, only some stocks make up a large portion of those funds. For instance, Nvidia alone represents 7.5% of the Invesco QQQ ETF. When one of these major stocks takes a hit, it's going to bring down the rest of the index, as in the sharp drops in major funds.

Exposure

An important lesson learnt is to know what one owns and for what reason, as per The Motley Fool. That means a true understanding of your exposure, whether direct or through a fund that makes up an index. For example, if you own $3,500 in Nvidia stock but also have $100,000 in an S&P 500 index fund, your true exposure to Nvidia is over $10,000 because it makes up such a large amount of the index.

Managing market risk without overhauling your strategy

While the risk of concentration is something investors should be mindful of, it does not necessarily mean you should flip your entire investment strategy, as per the report.

Companies like Nvidia have grown substantially because their earnings are strong and profit margins have expanded. The S&P 500 remains a great tool for long-term growth, reported The Motley Fool.

The Motley Fool suggested a periodical review of one's portfolios as it is very crucial to avoid over-exposure to one or a handful of companies and sectors.

FAQs

Should I change my entire investment strategy after such a big drop in Nvidia’s stock?
Not necessarily. The drop serves as a reminder of the risks of concentration, but it doesn’t mean you should overhaul your investment strategy. The S&P 500 remains a strong tool for long-term growth, as per a report.

How can I protect my portfolio from concentration risk?
To manage concentration risk, it’s essential to be aware of your investments’ composition. Regularly review your portfolio to ensure it remains diversified across sectors and companies. If you find that you have too much exposure to a single stock or sector, consider rebalancing or diversifying into other areas to reduce the potential risk of big losses.