1 Costly Mistake Too Many Investors Make With the Vanguard S&P 500 ETF (VOO)
Key Points
The Vanguard S&P 500 ETF (VOO) is the cornerstone of many retail investor portfolios.
Many investors think they're getting a broad cross-section of the U.S. economy.
In reality, they're getting a concentrated, tech-heavy portfolio that's heavily influenced by just a few stocks.
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The S&P 500 (SNPINDEX: ^GSPC), despite its diversified simplicity, has become one of the best investments of the past decade. Over the past 10 years, the Vanguard S&P 500 ETF (NYSEMKT: VOO), which tracks the well-known index, has generated a total return of 327%. That's not quite as good as many tech and growth exchange-traded funds (ETFs) over the same period. But a 15.5% average annual return from a diversified basket of large-cap stocks is really good by almost any measure.
Well, diversification is what many investors think they're getting with the S&P 500, at least.
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The truth is that the index is as overweight tech today as it's ever been. With a 35% allocation, the S&P 500 looks less like a fully diversified portfolio and more like a tech fund with other sectors sprinkled around the edges.
Image source: Getty Images.
The S&P 500 isn't nearly as diversified as you think
The concentration problem isn't just limited to the sector level. While the percentage of assets committed to tech is the highest it's been since the launch of the Vanguard S&P 500 ETF in 2011, it's not the only area exerting significant influence.
The percentage of stocks categorized as growth stocks within this ETF (50% as of late last year) was also at its highest level since inception. The concentration of assets within the top 10 holdings? Also at a since-inception high at nearly 40%.
Investors think they may be getting a broadly diversified portfolio when they invest in the S&P 500. By the number of stocks held within the index, that may be true. But it's also true that an investment in the S&P 500 is largely controlled by a dozen stocks or fewer.
Solving the S&P 500's diversification problem
There are a couple of ways to address this problem.
If you want to stick exclusively with U.S. large-cap stocks, the Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP) provides a more diversified mix of sectors. Tech is still the largest sector holding, but only at 19% of the fund. Four other sectors have weightings of 9% or more. It's the same basket of stocks, but much more spread out.
The other thing that's ignored with the S&P 500 is an allocation to small caps and international stocks. As we've seen over the past year or so, these two groups have had their moments that demonstrate why they're so important to a diversified portfolio. They have different exposures and economic influences that can provide true diversification benefits when combined with the S&P 500.
The Vanguard S&P 500 ETF remains a solid investment that can serve as the cornerstone of a portfolio. But it's not perfect, and it can be improved.
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David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
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