Key Points
The Vanguard S&P 500 ETF has a market-weighting to S&P 500 members.
The Invesco S&P 500 Equal Weight ETF holds those same 500 stocks at roughly equal weightings.
Mega-cap tech stocks have gained significant value over the past few years, driven by AI enthusiasm. That's causing heavy concentration at the top for the Vanguard S&P 500 ETF (NYSEMKT: VOO), which tracks the S&P 500 through a market-cap-weighted approach. That's why, if the index gets too concentrated at the top, I'd choose the Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP), which, as the name implies, invests in the same 500 stocks, but with a roughly equal weighting to each one.
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Striking a balance
The Vanguard S&P 500 ETF passively tracks the S&P 500 index. As companies grow in size, they have a higher weighting in the index. Currently, eight of its 10 largest holdings are tech-related stocks with meaningful AI investments. Its top ten holdings account for nearly 40% of the index, led by Nvidia at 7.6%. On the one hand, the high allocation to these fast-growing AI stocks has helped drive VOO's strong returns in recent years. It has delivered more than a 15% annualized total return over the past decade, well above the S&P 500's historical average return of around 10%. However, the S&P 500's top-ten weighting has doubled during that period, surpassing the dot-com bubble peak.
Contrast VOO's concentration with the Invesco S&P 500 Equal Weight ETF. It has a vastly lower overall concentration, as its top ten holdings account for just over 3% of its total assets. Meanwhile, its top holding, Moderna, has a small allocation at around 0.6%.
That concentration difference matters. If Moderna were to crash, it wouldn't have much impact on RSP. However, if Nvidia or one of VOO's other large holdings craters, it would have a meaningful impact on its returns.
I still think VOO is a terrific ETF and wish I had bought shares a decade ago. However, if its top holdings ever grew too large (over 50%), I'd choose to buy RSP instead for a passive S&P 500 investment. While that might give up some additional AI-driven upside potential, it would help provide downside protection ahead of a potential AI stock correction.
Matt DiLallo has positions in Moderna. The Motley Fool has positions in and recommends Moderna, Nvidia, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.