Why Investing in S&P 500 Index Funds Is a Whole Lot Riskier These Days

The S&P 500 gives investors access to the top stocks on U.S. markets, including Nvidia and other big tech giants. It has been a terrific index to track not only for years, but also for decades. Over the long run, it has averaged an annual return of around 10%, making it an ideal index to track via exchange-traded funds (ETFs).

The Vanguard S&P 500 ETF (NYSEMKT:VOO) is a popular option for that purpose, as it has a low expense ratio of just 0.03%, making it a suitable set-it-and-forget-it investment for the long haul.

However, investing in S&P 500 index funds is riskier these days than it has been in the past. And a big reason is due to its exposure to the tech sector.

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The S&P 500 is heavily tilted toward tech

A big reason the S&P 500 has done so well in recent years is the growth many tech stocks have experienced. It's not only Nvidia; other chipmakers and companies involved in selling memory and other related AI infrastructure have been doing exceptionally well, with their share prices skyrocketing in the process.

All 10 top holdings in the Vanguard S&P 500 ETF, for instance, have exposure to AI. Nvidia, Apple, and Microsoft account for around 22% of the portfolio. But that rises to nearly 40% when including the largest 10 holdings, which is a heavy exposure to tech that may not be appropriate for risk-averse investors.

Focusing on non-tech sectors could be key for investors right now

There's growing concern that an AI bubble may have already formed and that many tech stocks may be vulnerable to near-term corrections. While holding S&P 500 index funds can still be a good long-term option, if there's a prolonged downturn in the markets, it could take several years for a recovery to occur; many investors may simply not be willing or able to wait that long.

That's why, for many investors, it may be more appropriate to consider ETFs that don't simply track the S&P 500 but instead track dividend stocks or defensive sectors of the market, which will be less vulnerable to significant declines.

While no investment is entirely risk-free, there are steps investors can take to reduce risk these days. Tracking the S&P 500 can still be a good option, but it may not make the most sense for all investors, especially those who aren't prepared to hang on for several years.

David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Microsoft, Nvidia, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.