VOO: The S&P 500 Should Be The Cornerstone Of Your Portfolio

MicroStockHub/E+ via Getty Images My followers know that I advise them to build a well-diversified portfolio and to hold it through the market’s up-n-down cycles. They also know that I believe they should build such a portfolio on the foundation of the S&P 500. Today, I will review many of the reasons supporting this advice and explain why an excellent choice for the foundation of your portfolio is the Vanguard S&P 500 ETF (NYSEARCA:VOO). I’ll start with a simple chart comparing the 10-year total returns of the three broad market averages over the past decade: the DJIA, the S&P 500, and the Nasdaq-100 as represented by the DIA, VOO, and QQQ funds, respectively: Data by YCharts As you can see by the graphic, the S&P 500 has more than doubled over the last 10-years and has out-performed the DJIA by almost 40%. The Nasdaq-100 is the technology laden and much more volatile index and is the clear winner of the three, which is why a well-diversified portfolio should also include strong exposure to the technology sector. Investment Thesis In my past articles on portfolio management, I have advised investors to adopt a top-down allocation strategy to construct a portfolio that meets their own personal considerations such as age, working/retired, goals, risk tolerance, health, etc. Such a strategy typically results in a portfolio containing a number of investment categories in which the investor determines how much capital he/she wants to allocate capital. For example, and simply for the sake of discussion (acknowledging that each investor’s allocation decisions will differ based on the previously mentioned factors …), such a well-diversified portfolio might look something like this: CATEGORY ALLOCATION S&P 500 40% Income/Dividend Growth 10% Growth/Technology 25% Sector-Specific ETFs 5% Speculative Growth 5% Precious Metals 5% Cash 10% Click to enlarge The reasons to have the S&P 500 as the foundation (i.e. the biggest allocation) of this portfolio are many and include: Research shows that over the long term, the vast majority of ordinary investors – and even the majority of professional money managers – do not achieve the average annual returns of the S&P 500. The S&P 500 holds the biggest and most dynamic companies on the planet, while also being a diversified fund of 500 companies. Typically, S&P 500 ETFs are very economical because they have low expense fees (VOO’s expense fee is only 0.03%). As shown earlier, the S&P 500 is a proven way to build wealth over the long-term (the average 10-year annual return of the VOO ETF since inception in 2010 is 14.5%). So, let’s take a closer look at the VOO ETF. I’ll start with the portfolio. Top-10 Holdings The top-10 holdings in the VOO ETF are shown below and were taken directly from the Vanguard VOO ETF webpage, where you can learn more detailed information about the fund: Vanguard As you can see by glancing at these holdings, the top-10 holdings in the S&P 500 give investors strong exposure to the technology sector and to what is arguably the biggest investment theme of our time: AI. Apple (AAPL) is the #1 holding with a 6.9% weight. As you know, Apple has a very strong global brand and operates a number of consumer platforms (iPhones, iPads, Macs, Services, etc.) that each have a huge installed customer base. That being the case, Apple can easily leverage that installed base to roll out new AI-enhanced products. While Apple’s growth rate has arguably slowed over the past few years, the company consistently generates strong free-cash-flow, is well-positioned for the future, and ended its most recent quarter with $33.9 billion in cash & cash equivalents. Note, the S&P 500 is also well-represented by the hyperscalers: the top-3 companies that dominate cloud-computing. Microsoft (MSFT) is the #2 holding in VOO with a 6.7% weight and operates the #2 cloud platform (Azure). Amazon (AMZN), which operates AWS – the leading cloud platform – is the #5 holding with a 3.7% weight. I say #5 because, in aggregate, Alphabet’s two classes of Google (GOOG) stock equate to 4% of the VOO ETF, which makes it the true #4 holding. Google operates the #3 cloud platform (GCP) and in Q2 generated $10 billion+ in revenue (+28% yoy) and over $1 billion in operating profit from its cloud segment. It was the first-time Google exceeded those revenue and profit thresholds for its cloud-segment. These hyperscalers all have common attributes: They operate the leading cloud platforms on the planet. They can leverage AI across their cloud-platforms. They have other tangential businesses in which they can leverage their cloud offerings to roll out and, more importantly, monetize AI applications. Now, all three of these hyperscalers have been criticized for “over-spending” on AI. However, as I pointed out in my recent article on The Technology Select Sector SPDR Fund ETF (XLK), these companies continue to grow their operations and generate strong free-cash-flow (see XLK: If You Are Underweight Tech Stocks, This Is The ETF For You). The bottom line is that these companies are spending heavily to build-out AI data centers because they can easily afford to do so. And, they know the risk of not doing so is falling behind. After all, AI is nothing without the compute power and high-speed networking required to run AI algorithms on large language models (LLMs). All three of the hyperscalers will be leaders in AI for many years to come. Speaking of compute power, note the VOO ETFs #3 holding is Nvidia (NVDA) with a 6.2% weight. While Nvidia is frequently seen as only a chip-design outfit. However, I believe its CUDA AI software is a critical component of its success because it enables developers to more easily use its high-performance GPUs as cloud-based compute appliances across a broad number of exciting industry applications. And, speaking of high-speed networking, Broadcom (AVGO) is one of my favorite technology stocks and is the #9 holding with a 1.5% weight. Broadcom operates what is arguably the best high-speed networking development platform on the planet (i.e. both hardware & software) and, as a result, always appears to be a generation (or two …) ahead of the competition. Broadcom’s networking solutions enable powerful data-hungry AI compute-engines to be fed with the high-bandwidth, low-latency data they require to reach their full computing potential. Broadcom also designs AI computer chips for a select group of hyperscalers and is on its sixth generation of silicon for Google (in comparison, Microsoft recently took delivery of its first AI-specific silicon). In addition, Broadcom’s recent acquisition of VMWare has significantly increased its high-margin Enterprise Software Segment’s revenue. And, as I have pointed out in my Seeking Alpha articles, many investors may have over-looked the fact that Broadcom has a strategic partnership with Nvidia to enable VMWare’s virtualization software full-stack support to run Nvidia’s GPU offerings. The point here is that VMWare’s customers can run either Nvidia GPUs or Broadcom’s own in-house designed AI compute engines. See Broadcom Q1 Earnings: CEO Hock Tan At His Best (Wheelin’ & Dealin’). From an overall perspective, VOO’s portfolio is – not surprisingly – most highly exposed to the Information Technology sector, with a 31.4% weight: Vanguard In my opinion, that is exactly what investors should want, given my opinion that the Technology Sector is the place to be for the 21st Century. That’s because, as I have written repeatedly on Seeking Alpha, we are in the early innings of what is a long-term secular bull-market in Tech that will last for many years to come (perhaps for decades). That said, the VOO ETF is also well-represented by the Financial Sector (13%), the Health Care Sector (12%), and Consumer Discretionary (10%). As you can see from the list, VOO is a relatively well-diversified portfolio. Performance As mentioned earlier, the VOO has an excellent long-term performance track record: Vanguard As you can see from the graphic, the fund has an 10-year average annual total return of 13.1%. In my opinion, this is one reason to build your portfolio on the foundation of the S&P 500. After all, in my opinion, you cannot “beat the market” until you first achieve the total returns of the S&P 500. Now, there is a lot of talk about the S&P 500 being too heavily over-weighted in a handful of technology stocks and many of the analysts making this (rather obvious …) observation pound the table recommending an equal-weight fund, perhaps like the Invesco S&P 500 Equal Weight ETF (RSP). The following chart compares the total returns of the two funds over the past 10-years, and I will let you make the (again, rather obvious …) conclusion: Data by YCharts Valuation The S&P 500 is the broadest of major market indexes, and its valuation metrics are shown below: Vanguard Investment valuation metrics are typically compared against the S&P 500, but here we simply have the S&P 500. Compared to the Nasdaq-100’s P/E = 40x, the S&P 500 is a relative value. However, on a price-to-book basis, it is the Nasdaq-100’s P/B = 3.6x that is the better bargain as compared to the S&P 500. Note the excellent earnings growth rate (17.9%) and impressive ROE (24.6%) of the S&P 500. The current yield of the VOO ETF is 1.26%. That being the case, the long-term investment thesis for the S&P 500 is capital appreciation, not income. Risks The VOO ETF is obviously exposed to all the risks and ups-n-downs of the global macroeconomic environment (interest rates, recessions, wars, etc.) and associated political risks – like the upcoming U.S. presidential election. My view is that it would be very bearish for the U.S. and global economies (and thus the S&P 500) if ex-president Trump wins in November and actually follows through with his vows to impose 60-100% tariffs on China, to deport millions of migrants, and to take over the Federal Reserve’s job to set interest rates. This is one reason investors should always keep a significant cash position within the portfolio. That way, you can take advantage of big market sell-offs and add to your position. Currently, there are a plethora of investment risks, including geopolitical (wars in Ukraine/Russia and the Middle East), political (the upcoming U.S. presidential election), inflation, and China slow-down. Counteracting these negative risks are a continuing relatively strong U.S. economy and excellent profitability within the S&P 500: despite seemingly never-ending recession fears, FactSet reports that S&P 500 Q2 earnings so far are +10.8% yoy with 78% of companies reporting upside EPS surprises. Meantime, the prospects for imminent interest rate cuts by the Federal Reserve are a very positive catalyst going forward. To reduce the risk of market timing, I strongly suggest investors reach their category capital allocation goals (including in the S&P 500) over a period of time by scaling into these investments relatively slowly… over a period of weeks and months and, perhaps years (for example, it took me three years to establish a full-position in the QQQ fund). That way, you won’t kick yourself for going “all in” at the top of a market cycle before a big sell-off, and won’t kick yourself for “missing” out of a bull-run either. A word about “timing the market”: research shows that ordinary investors (and professional money managers) are terrible at timing the market. After all, you have to be correct twice: when to get out, and when to get back in. This has given rise to a phrase in which I subscribe to: rather than timing the market, it’s all about time IN the market. Summary & Conclusion The VOO ETF is an excellent S&P 500 fund to build your well-diversified portfolio around. It is highly affordable given its very low 0.03% expense fee and has an excellent long-term performance track record. The fund is chock-full of the biggest, best, and most dynamic U.S. companies – all of which have strong global brands, are highly profitable, and generate strong free-cash-flow. I always have a Buy rating on the S&P 500 because my personal strategy is to frequently take advantage of market volatility to add to my existing position.

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