The Vanguard Total Stock Market ETF (NYSEMKT: VTI) owns roughly 3,500 U.S. stocks. That sounds like strong diversification for a single fund. It isn’t.
The problem exists with the top-heavy concentration at the top of the portfolio. The fund’s top three holdings are Nvidia, Apple, and Microsoft. Combined, they account for 17% of the fund’s assets. Top-10 holdings account for 32%. That’s a lot of influence from just a handful of stocks.
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The concentration problem inside total market funds
This is a consistent problem that occurs in almost any exchange-traded fund (ETF) that weights its holdings by market cap. In any S&P 500 fund, such as the Vanguard S&P 500 ETF, between 30% and 40% of the portfolio is in less than a dozen stocks.
It gets worse in sector funds. The VanEck Semiconductor ETF has nearly 50% of its portfolio in just five stocks: Nvidia, Taiwan Semiconductor Manufacturing, Broadcom, Intel, and Advanced Micro Devices. The State Street Energy Select SPDR ETF has 39% of its portfolio in just two stocks: ExxonMobil and Chevron.
True diversification doesn’t come from the number of stocks in a portfolio. It depends on the weights of those components and how much idiosyncratic risk a fund exposes its shareholders to. If you’re investing in a total market fund, odds are you’re making a larger bet on fewer stocks. It’s best to understand this before you dive in.
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