The Vanguard S&P 500 ETF (VOO 0.01%) is one of the most popular investment vehicles in the world. Including the mutual fund version of the ETF, there is $1.6 trillion in total assets invested in the low-cost Vanguard product.
To be clear, there are good reasons why so many investors use the Vanguard S&P 500 ETF as the backbone of their portfolios. The S&P 500 is considered the best indicator of how U.S. large-cap companies are doing, and Vanguard’s version has a rock-bottom 0.03% expense ratio, making it an extremely cost-effective way to get exposure.
1 big problem with the S&P 500
The S&P 500 has produced extraordinary returns over the past decade or so, and the biggest reason why is the stellar performance of the mega-cap tech stocks. But this has also produced what I consider to be the biggest drawback of investing in the S&P 500 — it has become extremely top-heavy.
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Nvidia (NVDA 0.99%) alone makes up nearly 8% of the benchmark index, and Apple (AAPL +0.87%) now accounts for about 6.5%. The 10 largest companies in the S&P 500 now make up 40% of the index. And the 22 largest S&P companies account for as much of the index’s weight as the 478 smallest names in the index.
In a nutshell, by investing in the S&P 500, you’re betting heavily on the largest companies in the market. If one of the top stocks performs poorly, it can drag the index lower all by itself.
I’d buy this alternative instead
One way to invest in the S&P 500 without the concentration risk is with the Invesco Equal Weight S&P 500 ETF (RSP 0.07%). Just as with the Vanguard S&P 500 ETF, you’ll invest in the 500 large-cap companies that make up the index, with the big difference that an equal amount of money will be invested in every single company.
In other words, each of the 500 companies accounts for about 0.2% of the ETF’s assets. This means that a relatively small S&P 500 component like First Solar (FSLR +1.44%), or eBay (EBAY 4.29%), carries the exact same weight in the index as Apple or Nvidia.
Here’s what this means to you. The Invesco Equal Weight ETF still gives you broad-based exposure to American business — just without the concentration risk. For example, if Nvidia were to fall by 20% due to a bad earnings report, you’d barely notice it in the performance of this ETF.
Finally, you might be surprised to learn that over the long term, the equal-weight S&P 500 has actually marginally outperformed the traditional version of the index. Of course, there’s no guarantee that this will happen in the future, but the point is that you can get similar wealth-building potential with less exposure to the mega-cap tech stocks.
Matt Frankel, CFP has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Apple, First Solar, Nvidia, Vanguard S&P 500 ETF, and eBay. The Motley Fool has a disclosure policy.
