60% of my net worth is sitting in S&P 500 index funds – am I diversified enough?

Diversification is one of the few “free lunches in investing,” as Harry Markowitz, once said. When it comes to free lunch, you’ll want a seat at the table, whether you’re a new investor or a more seasoned one. Indeed, diversification can lower the degree of market risk you’ll take. But up to a certain point (after some number of holdings across varied industries and sectors), you won’t be able to take out that remaining risk.

As such, it’s important to remember that diversification can only take you so far. At the end of the day, there’s an unavoidable amount of risk you’ll need to bear as an investor in equities. Of course, a long-term mindset, a cool-as-a-cucumber mood amid market panics and crises, and a nose for value are all traits that can help you on your investment journey.

In the case of this Reddit user who recently posted to the r/ChubbyFIRE subreddit, they’re wondering if they’re diversified enough with 60% of their total assets invested in one single security. To market newcomers, it sounds like the prospective early retiree is breaking one of the golden rules of diversification. After all, one should strive to keep no more than X% (this figure will vary for many) in any single stock.

S&P 500 index funds: A one-stop-shop portfolio diversified for U.S. investors

That said, when it comes to index funds and ETFs, you’re already getting instant diversification from an investment such as the Vanguard S&P 500 ETF (NYSEARCA:VOO). With the single ETF, you’re getting a basket of 500 U.S. stocks, which would give you a bright green checkmark when it comes to diversification. So, in short, yes, this Reddit user isn’t just diversified; they’re very well diversified by owning the stock market. But there is one caveat, they’re diversified across the U.S. stock market.

While U.S.-listed stocks through an S&P 500 index fund can provide some exposure to nations (for instance, Apple (NASDAQ:AAPL) sells a good chunk of iPhones in China), I do think that someone seeking comprehensive diversification may wish to pursue international stocks or ETFs. Undoubtedly, the U.S. stock market has shined bright compared to the rest of the world in recent years.

Diversifying beyond the U.S. would be a nice-to-have, in my view

The tides could turn at any time if they haven’t already. Given this, I’d argue that someone looking for a bit more diversification may wish to adopt a more global perspective.

Even Warren Buffett has shown a willingness to search for value outside of America with his bets on Japanese “sogo shosha” trading companies. Now, Buffett believes in America and he likely always will. However, if there’s a better deal overseas, it just makes sense to go after such a bargain, regardless of the country a firm is domiciled.

Of course, diversifying internationally won’t allow you to steer clear of those painful market plunges. At the end of the day, weakness in the U.S. stock market tends to cause shockwaves across the world. So, if the tariff sell-off intensifies, there may be no corner of the world where it’s safe to hide as an investor.

It’s not just geographic diversification that someone who’s heavy in the S&P 500 could improve upon. For an investor seeking a more balanced approach, other asset classes are more than worth diversifying into to enhance one’s risk-adjusted returns potential.

What about alternative investments and smaller-cap stocks?

Whether that entails buying bonds, real estate investment trusts (REITs), or fun collectables like watches, spreading one’s bets across more than just equities can improve upon that diversification factor, especially if global markets are on the cusp of a tariff-driven bear market. And, of course, there are small- and mid-cap stocks in addition to private equity investments that may offer a less-correlated return over time.

Incorporating such alternative assets or smaller-cap stocks likely won’t significantly cut market risks you’ll need to take much further. Though, they can help set the stage for a somewhat smoother ride for your portfolio.

Either way, such alternative instruments are worth considering for S&P 500-heavy investors looking for even more balance. After all, it takes more than one instrument to make up an orchestra.