The S&P 500 is often used interchangeably with “the market,” but there are important differences investors should make sure they know about.
There are about 8,000 securities traded on U.S. markets, including exchange-trade funds (ETF), but the S&P 500 includes only 500 stocks. These are all U.S. companies that have a market cap of at least $22.7 billion in addition to other criteria.
It’s also a weighted index, which means that stocks are weighted by market cap. The larger a stock is, the more of it is represented in the index. So when the S&P 500 makes a move, it could be highly influenced by its largest components. Today, it’s extremely tech-heavy.
The Vanguard S&P 500 ETF (VOO 1.21%) is the largest ETF in the world, by far, with $1.7 trillion in assets. It’s been approved by Warren Buffett, and Berkshire Hathaway previously owned it. But today, the Invesco S&P 500 Equal Weight ETF (RSP 1.50%) might be a better buy. Here’s why.
A few stocks make the most impact
The Vanguard ETF tracks the S&P 500, which means it’s a weighted ETF, and it buys and sells according to the index’s trades. Its largest positions are Nvidia, Apple, Microsoft, Amazon, and Alphabet, which together account for nearly 28% of the entire ETF.
Image source: Getty Images.
That’s been good for growth, since these top stocks have for the most part outperformed over the past few years, driving high gains for the broader index. However, it also creates risk in case anything happens to one of the stocks. It’s also highly skewed toward artificial intelligence (AI) at the moment, and it will always be highly skewed toward whatever is trending in the markets.
It might become even riskier if and when Space Exploration Technologies, or SpaceX, stock joins the index. It will automatically account for a high percentage of the total if it’s still one of the most valuable companies in the world by the time it gets in. If you don’t want to own SpaceX stock, you might not want to own the Vanguard ETF.
A real market sample
The Invesco ETF will still give you exposure to SpaceX stock if it joins the S&P 500, which it may be eligible for next year, but it will only be a small percentage, like all of the other stocks in the ETF, which are given similar weight.
The weighted index tends toward growth stocks, because their weight increases as they grow. It has tended to outperform the equal-weight ETF over time. However, the equal-weight ETF has been less volatile and has tended to outperform the weighted ETF during corrections. In 2022, for example, the last year when the S&P 500 reported an annual loss, the Invesco ETF fell 13%, while the Vanguard ETF fell 20%. This year, it’s also outperforming by a small percentage.
As AI continues to over-represent and the market looks heavy, the Invesco ETF might be the better buy.
