Should You Buy the Vanguard S&P 500 ETF? 3 Pros, 2 Cons

On a global basis, trillions of dollars are benchmarked to the S&P 500, the widely-followed gauge of U.S. equities. The hefty sum of capital allocated to S&P 500 stocks is reflected in the world of exchange-traded funds (ETFs).

The Vanguard S&P 500 ETF (NYSEARCA:VOO) Has Pluses and Minuses

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In the U.S. three of the four largest ETFs by assets are S&P 500-tracking funds and all three of those funds are among the few ETFs in the world with $100 billion or more in assets under management. The Vanguard S&P 500 ETF (NYSEARCA:VOO) is one of those funds. With $101.35 billion of assets under management, the VOO ETF is one of the largest ETFs in the world.

As its name implies, the VOO ETF’s “goal is to closely track the index’s return, which is considered a gauge of overall U.S. stock returns,” according to Vanguard. The VOO ETF “offers high potential for investment growth; share value rises and falls more sharply than that of funds holding bonds,” the company stated.

Many investors often look for what they consider to be the “perfect ETF,” which is a daunting task because aiming for perfection in the world of ETFs often results in finding moving targets. While it is accurate to say that the Vanguard S&P 500 ETF is a solid ETF, it is not perfect. Like any other fund, VOO has its pluses and minuses. Let’s explore some of those.

The VOO ETF Is Cheap

As has been widely documented, Vanguard ETFs are some of the cheapest on the market, and that label extends to the VOO ETF. The Vanguard S&P 500 ETF’s annual expense ratio is just 0.04% per year, or $4 on a $10,000 investment. Just five US-listed ETFs have annual fees of less than 0.04%, so VOO is among the least expensive ETFs in the U.S., regardless of asset class.

Additionally, Vanguard clients can trade VOO commission-free, enabling them to save more money.

It’s Liquid

Often, investors look at an ETF’s expense ratio and their brokers’ commission charges as the only costs they incur when buying and selling ETFs. However, there is more to the game than those elements. When assessing the total cost of ETF ownership, investors should also consider spreads, or the gap between what buyers are willing to pay and what sellers are willing to accept.

VOO and rival S&P 500 ETFs have tight spreads, usually around 1 cent, because the S&P 500’s most prominent names are large, highly liquid stocks. That helps keep the total cost of ownership low for investors in the Vanguard S&P 500 ETF.

It’s Representative of the Market

As the ETF industry has evolved, so have the weighting methodologies used by fund issuers, but weighting by market value is still the primary index structure. While the S&P 500 ETFs use a variety of weighting measures, the original version of the index, and the version offered by the VOO ETF, is a cap-weighted structure.

That means the largest companies have the largest weights in the Vanguard S&P 500 ETF. So the VOO ETF’s largest holdings currently are, in order, Microsoft Corp. (NASDAQ:MSFT), Apple Inc. (NASDAQ:AAPL) and Inc. (NASDAQ:AMZN).

Now for some of the VOO ETF’s disadvantages.

It’s Representative of the Market

This attribute is also a benefit of the Vanguard S&P 500 ETF, but market representation is not what some investors are looking for. One of the primary criticisms of cap-weighted indexes is that these benchmarks can expose investors to the gyrations of highly valued stocks because, as a stock’s price climbs, so does its weight in the S&P 500. Said another way, a cap-weighted index like the S&P 500 is based on what already happened, not attempting to anticipate what will happen.

Investors who were active in the markets during the dot com crash likely remember that when expensive stocks take over cap-weighted indexes and markets turn awry, things can turn ugly in a hurry.

Concentration Risk

The VOO ETF is home to just over 500 stocks, and Microsoft, which constitutes 3.70% of the Vanguard S&P 500 ETF, has the largest weight in the index. Plenty of ETFs have components with larger weights than that. However, there is an element of sector-level concentration risk in the S&P and the VOO ETF.

There are 11 sectors in the S&P 500, but just three – technology, healthcare and financial services – make up nearly half of the benchmark’s weight. Technology alone accounts for 20.59% of the VOO ETF.  That’s about six percentage points higher than the weight assigned to healthcare. As a result, it is difficult for VOO and its rivals to trade higher when technology stocks falter.

As of this writing, Todd Shriber owns shares of VOO.

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