This “Diversified” Vanguard ETF Is at Its Most Concentrated Point Since 1965. Here's What That Means for VOO Investors.

Many investors view the Vanguard 500 ETF (NYSEMKT:VOO), which tracks the S&P 500 Index, as a diversified investment because it holds shares of 500 of the largest publicly traded companies. However, it's not as diversified as it seems. Its top 10 holdings comprise almost 40% of its total value. That's its highest concentration since 1965 and well above the dot-com peak of 26%.

Here's what this heavy concentration means for investors in the Vanguard S&P 500 ETF.

Image source: Getty Images.

Concentrated at the top

A decade ago, the S&P 500's 10 largest holdings accounted for only about 17% of the index. Today, that number is approaching 40%, a level not seen since 1965. Back then, AT&T was its largest holding at over 9%. These days, Nvidia leads the way, accounting for over 8% of the S&P 500 (and VOO).

The biggest factor driving the concentration at the top of the S&P 500 is the growth in technology stocks, led by the "Magnificent Seven." This group of seven tech and tech-adjacent companies (Nvidia, Amazon, Meta Platforms, Microsoft, Apple, Alphabet, and Tesla) have delivered significant stock price appreciation. Over the past five years, the Magnificent Seven has gained 133.5% on average, more than double the 55.4% gain of the rest of the S&P 500. That outperformance has increased the group's concentration at the top of the S&P 500.

A history lesson

The last time the S&P 500 was this heavily concentrated was in 1965. Here's a snapshot of the top ten at that time:

• AT&T: 9.1%
• General Motors: 7.1%
• Standard Oil: 4.4%.
• IBM: 4.2%
• DuPont: 2.8%.
• Texaco: 2.7%.
• Sears, Robuck & Co.: 2.7%.
• General Electric: 2.2%
• Eastman Kodak: 1.7%
• Gulf Oil: 1.5%.

Only four of those companies have remained members the entire time. The rest either went bankrupt, merged with another member, or completed another corporate action.

The S&P 500's high concentration at the time led to a lost decade of returns. According to S&P data, from June 1965 through June 1975, the S&P 500 eked out an average annual return of only 1.2%.

Will history repeat?

Today's S&P 500's concentration is around one central theme: AI. Each one of the index's top 10 holdings is investing heavily to build out AI products and services.

The bull case is that we're still in the early days of the AI era. According to a McKinsey estimate, global investment in infrastructure to support traditional and AI workloads will reach nearly $7 trillion by 2030. That would drive continued growth in demand for AI chips from companies like Nvidia. Meanwhile, companies like Meta Platforms are just scratching the surface of the monetization potential of new AI services (e.g., Muse), which one analyst believes could add $10.8 billion in annualized revenue for the company by the end of next year. If AI lives up to its promise, shares of these AI leaders could continue to rise, increasing their concentration in the S&P 500 and growing the value of ETFs that track it like VOO.

However, the bear case is that AI fails to live up to the hype. If that happens, the S&P 500 could experience a sharp contraction as tech-related names lose value. A dot-com style bust could result in a 15-year recovery period for tech-heavy indexes.

What this means for VOO investors

Investors in the Vanguard S&P 500 ETF need to realize that it's not as diversified an investment as it might seem at first glance. It has a heavy concentration of the largest tech-related companies. That has its benefits and drawbacks.

This growing concentration has benefited VOO over the past decade, as the ETF has delivered a more than 15% annualized total return. That's higher than the S&P 500's longer-term historical average return, which is closer to 10%. If AI continues to drive growth for technology companies, the index will likely become even more concentrated as these leaders continue to outperform. However, if the heavy AI investments of the S&P 500's top 10 holdings don't deliver as promised, the index's returns over the next decade will likely be disappointing.

That's why investors should seek to complement VOO with other top ETFs with different holdings to further diversify their portfolios.

Matt DiLallo has positions in Amazon, Apple, Meta Platforms, and Tesla and has the following options: long December 2028 $650 calls on Meta Platforms, long June 2028 $180 calls on Amazon, short December 2026 $310 calls on Apple, short December 2028 $660 calls on Meta Platforms, and short September 2026 $280 calls on Amazon. The Motley Fool has positions in and recommends Amazon, Apple, International Business Machines, Meta Platforms, Microsoft, Nvidia, Tesla, and Vanguard S&P 500 ETF. The Motley Fool recommends General Motors. The Motley Fool has a disclosure policy.