Here's What Happens When You Only Invest in S&P 500 ETFs

You'll often hear that it's important to diversify your holdings in your brokerage account. If you only invest in a single industry, you'll risk major losses in a situation where that sector alone is negatively impacted. 

Take someone who focused their investing strategy on travel stocks in early 2020. Travel stocks took a huge hit that year due to pandemic-related shutdowns, which means anyone with most of their portfolio in travel stocks would've been looking at serious losses.

Now, there are different ways you can go about diversifying your portfolio. You could simply buy stocks across a range of market sectors. Or, you could load up on S&P 500 ETFs.

ETFs, or exchange-traded funds, trade publicly and consist of numerous stocks. You can buy sector-specific ETFs -- for example, travel ETFs. Or, you could buy S&P 500 ETFs.

The S&P 500 index consists of the 500 largest publicly traded companies today. The index is usually indicative of the stock market's performance as a whole. So when you buy S&P 500 ETFs, you're effectively putting your money into the broad market. You're also getting instant diversification.

Investing in S&P 500 ETFs can be a great strategy, especially if you're not so confident about choosing stocks individually. But should you only invest in S&P 500 ETFs?

The one time it's okay to choose a single investment

You wouldn't ever want to load up your portfolio with a single stock. But if you're buying S&P 500 ETFs, this is the one scenario where you might get away with only owning a single investment. That's because your investment gives you access to the broad stock market.

Meanwhile, if you only invest in S&P 500 ETFs, you won't beat the broad market. Rather, you can expect your portfolio's performance to be in line with that of the broad market. But that's not necessarily a bad thing.

See, over the past 50 years, the S&P 500 has delivered an average annual 10% return. That average accounts for years of strong performance as well as downturns.

A 10% return is a pretty good one. For context, a $6,000 investment that enjoys a 10% annual return over 40 years will grow into almost $272,000. So if you're happy with a portfolio that performs comparably to the stock market as a whole, then sticking to S&P 500 ETFs alone isn't a bad idea.

However, if you assemble a portfolio of individual stocks that perform better, you might enjoy a 12% or 15% return over time -- or more. A $6,000 investment that earns 15% a year over 40 years will grow into $1.6 million.

How much effort do you want to put in?

Putting your money into S&P 500 ETFs only might limit your returns to some degree. But in exchange, you'll have a lot less work on your hands. You won't have to research individual stocks for your portfolio and keep tabs on their performance quarter after quarter.

If you don't want to put a lot of effort into managing your investments, then S&P 500 ETFs are a good solution. But if you're willing to do the work, then you might do even better in the long run with a portfolio of hand-picked stocks (although, the odds are against you).

Another idea? Do both. Keep some of your portfolio in the S&P 500 but also add stocks you think offer exceptional value. With any luck, you'll enjoy solid returns as a result of a modest amount of research, but not an overwhelming amount.