Should you invest in ETFs or just own shares of Nvidia, Apple and Microsoft?

Investing in exchange traded funds (ETFs) can give you great diversification. But sometimes those ETFs can have significant exposure to just a few stocks, negating the benefit of investing in ETFs for diversification in the first place. And when you find a top-performing ETF that’s doing extremely well, that’s what you’ll often find: it’s doing well because of a few big positions.

Nvidia, Apple and Microsoft are the top three stocks in many funds

If you invest in growth or tech-focused funds, you’ll often find that tech giants Nvidia, Appleand Microsoft make up sizable positions in those ETFs.

For example, the Invesco QQQ Fund has grown by about 150% in the last five years. The Technology Select Sector SPDR Fund is up 170%. You might think that these are phenomenal investments that can also provide you with tremendous diversification to keep your risk low. But is it really so?

Nvidia, Apple and Microsoft account for nearly 25% of the Invesco QQQ Fund’s holdings. And this percentage rises to over 46% in the Technology Select fund. Depending on how this trio of stocks plays out, ETFs will largely follow as well. Not only do these stocks make up a significant portion of these ETFs, they are also industry leaders; how it performs can often be indicative of the technology sector as a whole.

This raises a simple question: Would you rather own just these three stocks or an ETF?

The Big Three versus ETFs

Let’s say you invested $10,000 in each of those three big stocks five years ago. If you did, the value of those investments would be worth a total of $353,000, with most of that coming from Nvidia, which would be worth $280,000 on its own.

NVDA data by YCharts

Now, what if you decided that the safer option would be to invest all that money in just one ETF. Together, that would mean putting $30,000 into a fund like the Invesco QQQ ETF, which gives you a position in the top 100 non-financial stocks on Nasdaq or the Technology Select fund, which focuses on the technology sector of S&P 500. Let’s also include on SPDR S&P 500 ETFwhich can provide even greater diversification. Here’s what a $30,000 investment from five years ago in each of these funds would be worth today:

• Select Technology Sector SPDR Fund: $80,000
• Invesco QQQ Fund: $73,000
• SPDR S&P 500 ETF: $56,000

Those returns don’t come close to the gains you’d get by just investing in the top three tech giants. Even if you exclude Nvidia and its outsized gains over the past two years due to its dominance of the chip market, your portfolio would still be worth about $73,000 from investing just $10,000 in Microsoft and Apple. At a total of $20,000, it would be a smaller investment and the earnings would be comparable to what you would get with the QQQ Fund when you invest $30,000.

Is it better to go with top stocks or an ETF?

Peter Lynch referred to it as “diworsification” rather than diversification, simply because by trying to become too diverse, you end up sacrificing too much in terms of potential returns. Having a few good stocks can sometimes be better than having hundreds of smaller positions that end up having disappointing returns.

Diversification can be useful if you are not comfortable picking stocks. But overall, investing in top tech stocks has generally been a good move for investors over the years. Although there will be bad years, in the long run, they are likely to generate great returns for your portfolio. And by going with the best and biggest names in the industry, you’re not necessarily taking on a ton of risk either.

If you are unfamiliar with a sector or just want extremely broad exposure, then an ETF may still be a desirable option for you. But for many investors, stock picking works well because you don’t have to get into the weeds and do a lot digging to find good investments to buy and hold; often the best and safest stocks to own aren’t that hard to find. Buying and holding shares of these three tech companies may be a better move than trying to find the right ETF.