The Vanguard S&P 500 ETF Is Riskier Than You Think. This Could Be a Better Option.

If you're in the process of saving and investing for retirement, building a diversified portfolio should be one of your top priorities. Having a diversified portfolio doesn't eliminate risk. But it could help minimize the damage when a single company or sector stumbles.

That's a big reason why the Vanguard S&P 500 ETF (NYSEMKT: VOO) has long been a popular choice among long-term investors. By putting your money into an S&P 500 ETF, you get to own hundreds of companies with a single investment.

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But the Vanguard S&P 500 ETF may not actually be as diversified as you think. And depending on your retirement savings timeline, risk tolerance, and goals, you may want to take a different approach to building your investment portfolio.

The Vanguard S&P 500 ETF has a big flaw

The Vanguard S&P 500 ETF tracks the S&P 500 index, which offers exposure to the roughly 500 largest publicly traded U.S. companies. And because the fund has a very low expense ratio, investors don't lose a lot of money to fees along the way.

But there's a catch. The S&P 500 itself is weighted by market capitalization. That means the biggest companies have the most influence on its total value.

That's particularly important today, because the S&P 500 has become increasingly concentrated in the tech sector. Therefore, when you buy shares of the Vanguard S&P 500 ETF, you might think you're getting equal exposure to a wide range of businesses when, in reality, you may be getting more exposure to a single volatile sector than you want.

Of course, the upside of heavy tech exposure is that the sector has delivered exceptional returns in recent years. But if you're inching closer to retirement or aren't comfortable with that level of concentration risk, then the Vanguard S&P 500 ETF may not be an optimal choice for you.

An equal-weight ETF could be a better bet

The Vanguard S&P 500 ETF is still diversified in its own right. But if you're looking for broader diversification with less concentration risk, the Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP) may be a better choice for you.

Instead of giving larger companies bigger allocations, the Invesco S&P 500 Equal Weight ETF gives each company within the S&P 500 roughly the same weight. This means that if one of the larger tech giants stumbles, it shouldn't have the same impact on your portfolio.

The Invesco S&P 500 Equal Weight ETF may be a more optimal investment if you're looking to reduce sector risk or if you already own a handful of tech stocks. In the latter case, with the Vanguard S&P 500 ETF, you may be doubling up on the same companies without even realizing it, making the Invesco S&P 500 Equal Weight ETF a better ticket to diversification.

One thing to keep in mind is that because the Invesco S&P 500 Equal Weight ETF rebalances on a regular basis, it has a higher expense ratio than the Vanguard S&P 500 ETF (0.2% compared to 0.03%). And during periods when the S&P 500's largest companies soar, the Invesco S&P 500 Equal Weight ETF could deliver lower returns than the Vanguard S&P 500 ETF.

If you're torn between the two, the right choice may boil down to what you're trying to accomplish, how far you are from retirement, and what your risk tolerance looks like. If you're comfortable knowing that a large chunk of your portfolio is concentrated in a few tech giants, the Vanguard S&P 500 ETF may be suitable for you. But if your goal is to maximize diversification and limit your risk, the Invesco S&P 500 Equal Weight ETF may deserve a closer look.

Maurie Backman has positions in Invesco S&P 500 Equal Weight ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.