The Smartest S&P 500 ETF to Buy With $500 Right Now

Investors who simply want to track the market generally tend to choose to invest in the S&P 500. Based on how the index is created — with a broad, diverse representation of the overall economy — it is a very solid choice.

There’s just one problem right now. The S&P 500 is trading at lofty levels, with a high concentration in technology stocks. Here’s why investors who want to own the S&P 500 index might find it a smart move to buy the Invesco S&P 500 Equal Weight ETF (RSP 0.37%).

What is the S&P 500?

The S&P 500 is a list of roughly 500 U.S. stocks that have been hand-selected by a committee. The actual goal isn’t for the stocks to be representative of the market; the intent is for the stocks, as a group, to represent the broader U.S. economy. The companies that get chosen are usually large and economically important, as you might expect.

The index employs a market capitalization weighting method. This essentially means that the largest companies comprise a larger percentage of the index. Thus, the largest companies have the biggest impact on the S&P 500 index’s performance. Since the largest companies tend to have the biggest impact on the economy, using market cap weighting makes a lot of sense.

There are several S&P 500 mutual funds and exchange-traded funds (ETFs) available for investors to purchase. Since they all do the exact same thing, it is probably a smart move to simply buy the cheapest alternative. For example, Vanguard S&P 500 ETF (VOO 0.03%) has an expense ratio of just 0.03%, which is as close to free as you are likely to find on Wall Street. However, there’s another option you may want to consider.

The problem with market cap weighting

Market cap weighting is a logical and appropriate way to mimic the economy. But it sometimes leads to problems, notably including concentrating the S&P 500 in hot stocks and sectors. Currently, for example, the technology sector accounts for approximately 35% of the index, which is a significant proportion. Three stocks, Nvidia, Microsoft, and Apple, account for a fairly material 21% of the index.

While the tech focus has helped push the S&P 500 index to record levels, it has also left the index highly concentrated and expensive from a valuation perspective. The average price-to-earnings ratio of the index is nearly 29, and the average price-to-book value ratio is 5.2.

An alternative to the S&P 500 that may interest more conservative investors is Invesco S&P 500 Equal Weight ETF. As the name implies, it doesn’t use market cap weighting, instead opting for equal weighting. This ETF costs a bit more, with an annual expense ratio of 0.2%. However, all the stocks in the ETF have the same opportunity to impact performance because of the use of equal weighting.

Tech stocks make up roughly 15% of the ETF, which is similar to the weighting of the industrial and financial sectors, with healthcare not too far behind. The top three stocks in Invesco S&P 500 Equal Weight ETF — Warner Bros Discovery, Micron Technology, and Western Digital — account for roughly 1% of assets. Note that this list doesn’t include Nvidia, Microsoft, or Apple.

On the valuation side of things, Invesco S&P 500 Equal Weight ETF looks a lot more attractive as well. The average P/E ratio is just under 21. The average P/B ratio is 3. So, more diversification and better valuation than the traditional S&P 500 index today.

It could be smart to err on the side of caution

There’s nothing wrong with a long-term investor buying an S&P 500 index tracker. If you do, opt for the cheapest alternative you can find, which will likely lead you directly to Vanguard S&P 500 ETF. But if you think the market is a bit too pricey today, you have a solid alternative in Invesco S&P 500 Equal Weight ETF.

Sure, it will cost you a little more to own, but it won’t leave you as exposed to the tech sector concentration that has emerged in the S&P 500 index thanks to market capitalization weighting. When a bear market arrives — and one will eventually arrive — a $500 investment in Invesco S&P 500 Equal Weight ETF, which will net you around 2.6 shares, could save you some of the pain of the drawdown.