History Says You Should Know These 3 Things Before Buying the Vanguard S&P 500 ETF (VOO) in September

When it comes to investing in the stock market for the long term, the most frictionless way to gain exposure is to buy an exchange-traded fund (ETF). The Vanguard S&P 500 ETF (NYSEMKT: VOO) is an excellent choice. Even the great Warren Buffett recommends this investment vehicle for most people.

It has an extremely low cost structure, charging an expense ratio of 0.03%. It also has a proven track record of compounding wealth. Betting on American companies has been a worthwhile endeavor.

But don't press the buy button just yet. History says you should know these three things before adding the Vanguard S&P 500 ETF to your portfolio in September.

Technology names have become a huge weighting

Even passive observers of the economy and markets fully understand just how dominant the technology sector has become, supported by the rise of the internet economy in recent decades. This shows up in the Vanguard S&P 500 ETF. The portfolio is representative of the U.S. economy, since it tracks the S&P 500 index.

The information technology sector accounts for 38% of the asset base, and the top 10 stocks in the ETF also make up 38% of the entire portfolio. This is one of the highest levels of concentration ever, rivaling the 1960s Nifty Fifty period, and it exceeds the dot-com era by a wide margin. In 2000, the top 10 companies represented 27% of the index, well below where we are today.

Investors who buy the Vanguard S&P 500 ETF are voting with their hard-earned savings that they're bullish on the leading technology companies. The list includes names like Nvidia, Apple, Alphabet, Microsoft, and Amazon, a group that makes up the ETF's top five holdings. All these businesses have tremendous exposure to artificial intelligence in unique ways, so you should be optimistic about its potential.

Recent returns have been above average

The past decade has been a boon for stock market investors. The S&P 500 index has generated a total return of 321% (as of Sept. 18). On an annualized basis, this translates to an outstanding total return of more than 15%.

From a historical perspective, though, this kind of performance is unusual. Since the S&P 500 index in its current form was created in 1957, it has posted an average annualized total return of 10%. Over a 10-year stretch, this type of gain would grow your starting capital by 159%, significantly lower than the appreciation seen in the last decade.

Maybe the next 10 years will lead to a reversion to the mean. The market's valuation certainly supports this argument. The cyclically adjusted price-to-earnings ratio is currently at 41. It hasn't been this expensive since the dot-com era. Past data tells us that when the multiple is above 40, investors will register negative annualized returns over the coming decade.

I don't believe this is a reason to be bearish, as the market has looked expensive for a long time now. However, investors should temper their expectations.

Volatility is normal

Even an established stock market like the one we have in the U.S. experiences occasional down cycles. This is normal. According to Fidelity, a bear market (20% fall from a recent high) happens roughly every six years. Corrections (10% drops from a recent high) are more frequent. You might be wondering why volatility is so normal. I believe it comes down to two key factors.

The first is that no two market participants are playing the same game. The trader working at a high-rise office building on Wall Street is trying to make money before the end of the day, while average households are putting money away for retirement 30 years from now. This leads to considerably different levels of trading activity.

The second factor driving volatility is that even if two market participants are playing the same game, they each interpret financial data, news headlines, and any other information in completely different ways. This results in different portfolio decisions.

For those who are thinking about buying the Vanguard S&P 500 ETF this month, be mentally prepared for stock prices to move in unpredictable ways, and don't be surprised when a downturn happens. This is the psychological entry fee that you must pay to generate wealth over time.

Neil Patel has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Microsoft, Nvidia, and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.