Warren Buffett Has Recommended 1 Investment for Decades -- but There's a Hidden Risk Many Investors Are Overlooking
Key Points
Buffett believes an S&P 500 ETF is still the best way for the average investor to build long-term wealth.
However, the S&P 500 has become tech-heavy in recent years because of surging valuations.
The "Magnificent Seven" stocks make up over a quarter of the Vanguard S&P 500 ETF.
- 10 stocks we like better than Vanguard S&P 500 ETF ›
Warren Buffett has rightfully earned his place as someone whose advice investors listen to and often apply. And through the years, his advice has remained consistent and effective. A common theme in his advice is that the best route for building wealth for the average investor is to consistently invest in an S&P 500 ETF.
The S&P 500 tracks around 500 of the largest publicly traded American companies, so Buffett equates investing in an S&P 500 ETF to investing in the broader U.S. economy. They may not be directly tied, but they tend to move in the same direction over time: up. Despite its impressive historical performance, there is an elephant in the room worth pointing out.
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The S&P 500 is more top-heavy than ever
Companies in the S&P 500 are weighted by their market values, so larger companies account for more of the index. Historically, that hasn't been a problem, but in the past few years, large tech companies have seen their valuations soar amid the current AI boom.
As of market close on July 2, there were 12 American companies with a market capitalization above $1 trillion, and all except Eli Lilly would be considered tech companies by most standards (though some are technically in different sectors). Three of those companies -- Nvidia, Apple, and Alphabet -- have market caps above $4 trillion.
Because these tech companies are becoming much more valuable than non-tech companies, they're accounting for a much larger share of the S&P 500 than before. For instance, the tech sector now accounts for 38.6% of the Vanguard S&P 500 ETF (NYSEMKT: VOO), the "Magnificent Seven" stocks account for just over a quarter of it, and each of its top 10 holdings is a tech company.
| Company | Percentage of the ETF |
|---|---|
| Nvidia | 7.89% |
| Apple | 7.05% |
| Microsoft | 5.14% |
| Amazon | 4.07% |
| Alphabet (Class A) | 3.41% |
| Broadcom | 3.26% |
| Alphabet (Class C) | 2.71% |
| Meta Platforms (Class A) | 2.13% |
| Tesla | 1.89% |
| Micron Technology | 1.68% |
Data source: Vanguard. Percentages as of May 31.
More risk, but still worth the investment
The concentration in tech stocks has worked to VOO's advantage in recent years, but it also carries more risk. The S&P 500 is still broad and contains companies from every major sector, but much of its performance is driven by the tech sector. When it's good, it can be great. When it's bad, it can be extra volatile.
VOO and other S&P 500 ETFs are still great investments; there's no doubt about it. But you can't ignore that one of its biggest selling points -- diversification -- isn't as strong as it has been historically. And it's much more concentrated now than it was when Buffett first championed it in his advice.
I still expect the S&P 500 to be one of the better long-term investments for the average person, so this isn't a call to jump ship. Just be mindful of the concentration, especially if you're investing in other tech-heavy indexes such as the Nasdaq Composite or Dow Jones.
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Stefon Walters has positions in Apple, Microsoft, and Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Broadcom, Eli Lilly, Meta Platforms, Micron Technology, Microsoft, Nvidia, Tesla, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
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