Diversified Investing with ETFs
At the time of this post, the S&P 500 and Nasdaq 100 index are at 52-week highs due to the Federal Reserve’s rate-hike pause. This year the Federal Reserve has raised interest rates every month, but for the first time in June, it paused the rate hike.
What is an ETF?
An ETF is an Exchange-traded Fund that operates similar to a mutual fund. The only difference is that these funds are traded on the stock market, unlike mutual funds. ETFs trace different indexes, sectors, and commodities. Generally, an ETF represents shares of multiple companies in a certain sector or commodity, therefore a popular choice for diversification. One of the most common ETFs is SPY which tracks the S&P 500. SPY is managed by State Street Global Advisors. Generally, these funds have a net expense ratio similar to how you pay a fee to mutual fund managers. Generally, people prefer ETFs over individual stocks, due to their diversification and reduced volatility. You don’t want to put all your eggs in one basket. It’s also easier to invest in ETFs than to do a lot of research (Fundamental Analysis and Technical Analysis) and predict which single stock will increase in value. Instead, you bank on the prospect that the US equity market will keep appreciating over time as it has a thriving economy. There are 100s of ETFs today, but we will cover some fundamental ones.
Some Fundamental ETFs:
SPY (SPDR S&P 500 ETF Trust) or VOO (Vanguard 500 Index Fund ETF)
These ETFs track the S&P 500. These are one of the largest ETFs in terms of AUM and are widely known. At the time of this post the S&P 500 is at its 52-week high due to the rate-hike pause. So, I would not expect it to give you an average 10% return like it has in them past. I would wait for a pull back or start dollar-cost averaging my money into the ETF. The S&P 500 has had an average of 10% return year over year. I would personally go with VOO as it has a lower expense ratio.
QQQ (Invesco QQQ Trust )
QQQ tracks the Nasdaq 100 index. It is managed by INVESCO. This ETF is fairly volatile as it tracks the Nasdaq 100 index. The QQQ ETF has a 13.5% compound annual return over the last 30 years. The stocks listed on Nasdaq are generally big tech companies like Apple (AAPL), Nvidia(NVDA), Microsoft(MSFT), etc so it generally does well when there are technological advancements. For example, this year, the popularity and usefulness of ChatGPT set off a chain reaction with other companies, like Palantir and C3.AI which gave massive returns, and Nvidia hit all-time highs due to its investment in Artificial Intelligence and their major role in making chips used in building A.I. systems. I believe in the future this ETF will do very well as A.I. further gains importance. Due to the AI news this year and the rate-hike pause the QQQ ETF has reached 52-week highs. If you are investing for the long term then I would advise dollar-cost averaging into this ETF but if you are looking for a high return in 6-12 months, I would let the price drop because you may not get the average 13.5% return at this price.
VNQ (Vanguard Real Estate Index Fund ETF)
This is an ETF that invests in shares of real estate investment trusts (REITs) that purchase real estate properties. Its net expense ratio is pretty high- 0.12%. In the last 30 years, it has had a compound average return of 8.35%. In the past year, the Vanguard Real Estate Index Fund ETF has not done well as there have been high-interest rates which inversely affect the real estate market because interest rates on lending increase Therefore, the price of the ETF has reduced. I believe that when the interest rates come down, we will see a high return on the Vanguard Real Estate Index Fund ETF.
VTI (Vanguard Total Stock Market ETF)
This ETF tracks the total US stock market. It gives you maximum exposure. It is very good for diversification. This ETF has more diversification than VOO or SPY but will consequently give less returns. It earned a compound annual return of 9.7% over 30 years. Again, Vanguard Total Stock Market ETF has reached its 52-week high because of the rate hike pause. I would advise either waiting for the price to drop or dollar-cost averaging into the ETF. If you’re looking for a long-term investment in 10 years then dollar-cost averaging is your best bet, but if you’re looking for a great return in 6-12 months you may want the price to come down because you might not get the average 9.7% return at this price.
Leveraged ETFs
“A leveraged ETF is an exchange-traded fund that uses financial derivatives and debt as leverage to amplify the returns of an underlying index.”(Chen, Investopedia.com.) These ETFs are generally risky but can yield very high returns. These ETFs are generally held for the short term, like for months or even days.
These are some of the leveraged ETFs I have used.
TQQQ (ProShares UltraPro QQQ ETF)
This leveraged ETF tracks 3x the daily change of the Nasdaq 100 index. This ETF is very common and has given YTD returns of 141.28%. This fund is very risky as it will give you 3x the losses of the Nasdaq 100 index too. TQQQ has a relatively high expense ratio of 0.86%.
SQQQ (ProShares UltraPro Short QQQ ETF)
This leveraged ETF tracks -3x the daily change of the Nasdaq 100 index. This is the exact opposite of what TQQQ does. As the tech sector has done very well in the past year, SQQQ’s price has gone down significantly as Nasdaq has gone up. SQQQ has a relatively high expense ratio of 0.95%
These are very risky investments and should only be held for the short term. If you believe the Nasdaq 100 index will go up and you wanted to amplify the return you would invest in TQQQ, but if you think otherwise and want to amplify your returns you would invest in SQQQ. These ETFs are generally used by people who have a high-risk appetite and are confident about market direction. Both ETFs are managed by Proshares.
In this post, I have only covered ETFs that are common or that I have used. There are many more ETFs you can use and research about on etf.com
Conclusion
ETFs are a great way to increase your exposure in the market and are generally safe investments. ETFs are truly unique investments because you can base your investment on how a certain sector or commodity may perform instead of banking on a corporation doing well. Also, these ETFs can be very effective if you understand market cycles.
“Most investors would be better off in an index fund.“
Peter Lynch
On to the next.
-Akash Gaonkar-
Bibliography :
Chen, James. “Leveraged ETFs: The Potential for Bigger Gains—And Bigger Losses.” Investopedia, 21 Apr. 2021, www.investopedia.com/terms/l/leveraged-etf.asp.
The financial advice provided is for informational purposes only and should not be considered as professional financial advice. Consult with a qualified financial advisor before making any financial decisions, as individual circumstances may vary. We do not guarantee the accuracy or reliability of the information provided, and we are not liable for any financial losses incurred.
