Portfolio diversification may seem like a tedious task, but it is an essential effort for 2026, especially considering the overwhelming dominance of the artificial intelligence trade throughout the previous year. Without implementing intelligent diversification techniques, your investment portfolio from 2025, which might have performed adequately, could become susceptible to significant vulnerabilities in the coming year.
Understanding the Need for Diversification
"Investors do not necessarily need to believe there is an AI bubble to be worried about the concentration risk that AI has created," explains Dan Lefkovitz, a strategist at Morningstar Indexes. "This concentration results in investors holding a market portfolio that is less diversified than in previous times—by individual stock, sector, and overarching theme."
Rebalancing Your Portfolio
Rebalancing serves as a method to reinstate the original level of diversification you initially established. If you have neglected rebalancing in recent years, your portfolio is likely overweight in US stocks compared to bonds.
"A portfolio that began with a 60% allocation to stocks and 40% to bonds a decade ago would now consist of more than 80% in stocks," calculates Amy Arnott, a portfolio strategist at Morningstar.
Additionally, assess your current exposure to international stocks: it is probably lower than your original target. "Even though stocks from outside the United States advanced in 2025, this followed a prolonged period of outperformance by the US market," says Arnott. "Consequently, your portfolio might still lack sufficient international exposure."
Adding Bonds for Enhanced Diversification
Financial professionals frequently argue that investors in accumulation mode, with many years until retirement, do not require bonds. However, "if you are over 50, I believe it is crucial to be realistic about de-risking a portion of your portfolio," advises Christine Benz, Morningstar's director of personal finance and retirement planning. "I support the concept of constructing a bulwark of safer assets, likely high-quality short- and intermediate-term bonds, along with a modest amount of cash."
In her model portfolios for retirement savers, Benz recommends a 5% bond allocation for those with 35-40 years until retirement. This increases to a 20% bond weighting once retirement is within 20 years.
For investors of any age seeking to diversify a US stock portfolio, bonds—specifically high-quality bonds—are an excellent choice, according to Benz. Even a small position in bonds can provide diversification that helps reduce portfolio volatility.
Allocating to International Stocks
Despite their resurgence in 2025, the performance of international stocks has still trailed that of US stocks over the past decade. This indicates that non-US stocks likely retain more potential for growth, even after their upturn last year.
Furthermore, non-US stock markets are less connected to technology and the AI trade, thereby offering diversification away from the trend that has driven much of the US stock market's returns in recent years. "Spreading one's investments across different geographies can be viewed as prudent risk management," states Lefkovitz. "The US accounts for just 25% of the global economy but 63% of its stock market value. Given this imbalance, an all-US equity portfolio reflects a significant home-market bias."
Boosting Value and Small-Cap Exposure
Investors who hold a diversified US index fund, whether tracking the S&P 500 or a total market index, have a pronounced large-cap emphasis in their portfolio. They also possess substantial exposure to the AI theme. To counter some of the concentration risk presented by the current US stock market, investors might consider allocating assets to smaller companies or value stocks—or diversifying into both through a small-value fund or exchange-traded fund.
"Small-cap value has consistently underperformed large-cap growth stocks, and I argue there is considerable value there, so investors might reposition slightly to avoid being overly tilted toward mega-cap growth and technology stocks," suggests Benz.
Incorporating Dividend Stocks
Dividend stocks typically cluster in sectors such as utilities, consumer goods, healthcare, industrials, and financials, which often perform well when technology sectors do not. Moreover, they tend to be less volatile than non-dividend-paying stocks and possess defensive characteristics, providing benefits during periods of market stress.
There are numerous strong dividend stock-focused ETFs and funds available, including options like the Schwab US Dividend Equity ETF (SCHD) and the Vanguard Dividend Appreciation ETF (VIG).
This article was provided to The Associated Press by Morningstar. Susan Dziubinski is an investment specialist for Morningstar and co-host of "The Morning Filter" podcast.
