ETFs
2 index ETFs to buy without moderation and 1 to avoid
Trying to beat the overall stock market with smart trading is a surefire way to underperform. Just keep things simple.
The temptation to seek the performance of the hottest stocks on the market is certainly strong. Everyone seems to be getting rich off them. Why not you?
However, as seasoned investors can attest, the proverbial grass is not always greener on the other side of the fence. A simpler, more passive approach often proves more rewarding.
Enter exchange-traded funds, specifically index funds exchange traded funds — or ETF — like the SPDR S&P 500 ETF Trust (TO SPY 0.12%). These funds are designed to help you avoid the risks of individual stocks by allowing you to easily own a diversified basket of stocks with at least one common attribute. In the case of the SPDR S&P 500 ETF, the common attribute is that all stocks are constituents of the S&P 500 hint.
With this in mind (and assuming you’ve already established a fundamental position in the SPDR S&P 500 ETF itself), there are a few ETFs you may want to consider getting into to further diversify your portfolio.
Oh, and there’s also a whole category of exchange-traded index funds that most investors are simply better off avoiding altogether.
Buy Invesco QQQ Trust
If you’re looking to add a little more momentum to your overall portfolio performance but aren’t sure which stocks are ready to do so, the Invesco QQQ Trust (QQQ 0.21%) is a smart option. Just be prepared for above-average volatility.
The so-called triple Qs (or “cubes”) reflect the performance of the Nasdaq-100 index, which includes 100 of the largest companies listed on the Nasdaq Sotck exchange. In itself, that doesn’t mean much. But it turns out that most of the best-performing stocks in the market over the past few years have become the mega-cap companies they are today while listed on Nasdaq. Some of these names include Microsoft, NvidiaAnd AmazonThis technology-heavy stock exchange is quite simply the place of choice for the world’s largest and fastest-growing technology companies to list their shares.
There is a downside here. That is, by simply mirroring the Nasdaq-100 Index, this ETF easily becomes overweight with the largest companies on the exchange due to the outsized gains of their stocks. For comparison, Microsoft, Nvidia, and Apple each currently represent just over 8% of the total index and fund value (around 25% for three stocks). This is not a particularly well diversified basket of technology stocks, despite a rebalancing imposed in July last year which aimed to avoid this type of imbalance! This imbalance, of course, exposes the Invesco fund to sharp and considerable declines once these high-flying market darlings fall even slightly out of favor.
It just doesn’t matter. The Invesco QQQ Trust is still more likely than not to hold many of the most promising technologies on the market. growth stocks whenever. If you can handle the volatility, it’s well worth the wild ride.
Buy the ProShares S&P 500 Dividend Aristocrats® ETF
Growth is one way for investors to create wealth. However, it is not the only way. An income-generating portfolio built on high-quality products split payment shares can also do the job properly.
It’s true! Although investors have not historically (not recently anyway) viewed dividends as the primary way to get rich, a little math clearly shows that an exchange-traded fund like ProShares S&P 500 Dividend Aristocrats® ETF (NOBL -0.24%) is indeed up to par. (Dividend Aristocrats® is a registered trademark of Standard & Poor’s Financial Services LLC.) There’s just one problem.
But let’s start at the beginning.
A Dividend Aristocrat® is simply the stock of an S&P 500 company that has increased its annual dividend payout for at least 25 consecutive years. Currently, more than 60 of these names qualify for the title, even though most of them have been increasing their annual payouts for well over 25 years.
Granted, the average yield here isn’t exactly exciting. ProShares says the fund’s current dividend yield is just 2.3%, leaving some potential investors wondering why this ETF should be considered a long-term winner. Sure, its steadily increasing dividend payout helps, especially when you reinvest those dividends in more shares of the ETF. Still, its long-term potential seems limited by its dividend bias.
The important detail that’s not obvious here is that stocks of companies with a policy of regularly increasing their dividends – and the ability to implement that policy – actually outperform most other stocks. Calculations by mutual fund company Hartford indicate that since 1973, stocks of companies that have reliably increased their dividend payments have posted an average annual gain of 10.2%. For perspective, an equally weighted version of the S&P 500 averages a more modest 7.7%. Stocks that didn’t pay dividends during that time averaged just an annual gain of 4.3%. Hartford concludes that companies that consistently generate dividends tend to simply be higher quality, better managed companies.
Oh, and the trap? The key here is to simply leave such a position alone for years while reinvesting one of those dividend payments into more shares of the stock or fund that pays them.
Avoid Short QQQ ProShares UltraPro
Last but not least, most investors will want to avoid ProShares UltraPro Short QQQ (SQQQ -0.60%) and other similar so-called “leveraged” ETFs. They simply pose too much risk for the average person.
If you’re not familiar with them, bearish exchange-traded funds rise when the market is falling. This is made possible in several ways, including simply shorting stocks found in a particular index. Most often, however, this is facilitated through trading in index-based futures or options that serve as short-term bets on the direction of an index. In the case of the ProShares UltraPro Short QQQ, the index in question is the aforementioned Nasdaq-100.
The ProShares Bear ETF is unique, even by ETF standards, in another way. In other words, it is also leverage, meaning it goes up and down much more than the underlying Nasdaq-100 goes down and up. For every 1% decline in the Nasdaq-100, the ProShares UltraPro Short QQQ gains 3% and vice versa.
The premise is compelling. All investors understand that the market moves up and down over time. Well-timed exposure to a leveraged bear fund like this could at least offset the impact of a market-wide correction. It could even prove to be a major source of income… if you plug into it at the start of the bear market.
These funds tend to be more trouble than they are worth and can easily do more harm than good.
You see, the long-term trend of the market is bullish even if it is sometimes interrupted by setbacks. Investors can afford be patientknowing that the market and its highest quality stocks will eventually recover.
This is not the case with bear funds, especially leveraged bear funds. Not knowing if the stock market has hit a major (or even minor) low until well after the fact means these ETFs can easily sink deep into the red before you even start thinking about cutting your losses. Never mind the fact that we tend to make bad decisions when we are stressed or anxious!
Therefore, the smart money approach is simply not to put yourself in a position where you would have to make such a difficult decision in the first place. Just be patient without trying to be cute or clever by doing something that the vast majority of people – including professionals – generally don’t do well.