Invesco QQQ Trust Is Great. Here's Why You Shouldn't Buy It.

The Invesco QQQ Trust (QQQ 1.54%) is one of the most popular exchange-traded funds (ETFs). It aims to track the Nasdaq 100 index, which includes the 100 largest non-financial companies listed on the Nasdaq exchange. It contains a who's who of the technology sector, counting Microsoft, Apple, Nvidia, and Amazon among its top holdings. 

The Invesco QQQ Trust has many endearing features. However, there are two big reasons investors shouldn't buy this leading ETF right now.

Concentrated at the top

Like the Nasdaq 100, the Invesco QQQ Trust holds 100 stocks (101 to be exact because Alphabet has two share classes). However, despite the appearances of diversification, the fund has a high concentration among its top holdings:

Data source: Invesco. NOTE: Holdings as of September 19, 2023. 

Those top-ten holdings make up nearly 49% of the fund's total, with almost all of those companies in the technology sector. That's actually a lower weighting than earlier this year after the Nasdaq 100 completed a special rebalancing to reduce its exposure to the seven largest companies.

Many investors already hold large allocations to these stocks. Because of that, buying this ETF would only further increase their exposure to these top stocks. Overall, technology makes up more than 57% of the fund. Consumer discretionary has the next highest weighting in the fund at almost 19%.

Those two sectors are very cyclical. That makes them more susceptible to earnings and stock-price declines during a recession. Investors typically want to avoid buying cyclical stocks when a recession appears to be approaching.

An expensive investment

The Invesco QQQ Trust is a relatively inexpensive fund, given its 0.2% ETF expense ratio. However, the stocks in the fund are rather expensive. 

The Nasdaq 100 currently trades at 30.6 times earnings and 27.3 times the forward price-to-earnings (P/E) ratio. That's up from about 25 times earnings a year ago, following the 18% surge in the Nasdaq Composite over the past year. 

For comparison, the S&P 500 trades at 20.3 times earnings (current and forward), while the Russell 2000 Index sells for 26.1 times earnings (and 22.6 times forward P/E). While the stocks in those indexes (and the ETFs that track them) aren't exactly cheap, they're not quite as expensive as the Nasdaq 100.

Interestingly, investors can get similar exposure to the top Nasdaq 100 holdings through an ETF tracking the cheaper S&P 500. For example, the SPDR S&P 500 ETF Trust's (SPY 0.95%) top-ten holdings are:

Data source: State Street. NOTE: Holdings as of September 19, 2023.

With this S&P 500 ETF, investors gain meaningful exposure to the same top-seven companies (nearly 28% of the fund's holding) at a lower overall valuation than the Nasdaq 100-tracking Invesco QQQ Trust. Meanwhile, this ETF offers greater overall diversification since it has a lower weighting to its top holdings, and technology only makes up about 27% of its holdings. It also features a lower ETF expense ratio (0.09%). 

It's better to wait to buy this ETF

The Invesco QQQ Trust is a great ETF. It provides investors with exposure to the top 100 non-financial stocks trading on the Nasdaq at a reasonable cost.

However, it's not a great ETF to buy right now. It has a very high concentration to the seven largest (primarily technology) companies and has significant overall exposure to cyclical stocks. Furthermore, it trades at a pricy valuation. Because of that, it could underperform if the economy enters a recession.

On the other hand, S&P 500-focused ETFs like the SPDR S&P 500 ETF Trust count the same top-tech titans among its top holdings, though at a much lower percentage (and greater overall diversification). Meanwhile, this ETF trades at a cheaper valuation and lower expense ratio. Because of that, it looks like a much better option for investors than the Invesco QQQ Trust right now.