2 Index ETFs to Buy Hand Over Fist and 1 to Avoid
The temptation to chase the performance of the market's hottest stocks is strong to be sure. Everyone else seems to be getting rich off of them. Why not you?
As veteran investors can attest, however, the proverbial grass isn't always greener on the other side of the fence. A simpler, more passive approach often ends up being a more rewarding one.
Enter exchange-traded funds, and specifically, index-based exchange-traded funds -- or ETFs -- like the SPDR S&P 500 ETF Trust (NYSEMKT: SPY). Such funds are designed to help you sidestep the risks of individual stocks by allowing you to easily own a diversified basket of equities with at least one common attribute. In the case of the SPDR S&P 500 ETF, the common attribute is the fact that all of the stocks are constituents of the S&P 500 index.
With that as the backdrop (and assuming you've already established a foundational position in the SPDR S&P 500 ETF itself), there are a couple of ETFs you may want to consider stepping into to further diversify your portfolio.
Oh, and there's also a whole category of exchange-traded index funds most investors are just better off simply avoiding altogether.
Buy the Invesco QQQ Trust
If you're looking to add a little more zip to your portfolio's overall performance but aren't sure which stocks are poised to dish it out, the Invesco QQQ Trust (NASDAQ: QQQ) is a smart option. Just brace for above-average volatility.
The so-called triple Qs (or "cubes") mirror the performance of the Nasdaq-100 index, which consists of 100 of the biggest companies listed on the Nasdaq stock exchange. That in and of itself doesn't mean much. But, as it turns out, most of the market's best-performing tickers over the course of the past several years became the megacap companies they are today while listed on the Nasdaq. Some of these names include Microsoft, Nvidia, and Amazon. This tech-heavy exchange is just the preferred place for the world's top -- and highest-growth -- technology companies to list their stocks.
There is one downside here. That is, by merely mirroring the Nasdaq-100 index, this ETF easily becomes overweighted with the exchange's biggest companies due to their stocks' oversized gains. For perspective, Microsoft, Nvidia, and Apple each currently make up a little more than 8% of the index's and fund's total value (roughly 25% for three stocks). That's not an especially well-diversified basket of tech stocks, and that's despite a rebalancing imposed in July of last year that was meant to avoid this very sort of imbalance! This imbalance of course leaves the Invesco fund subject to sharp, sizable pullbacks once these high-flying market darlings fall even just a little out of favor.
It just doesn't matter. The Invesco QQQ Trust is still more likely than not to be holding most of the market's most promising technology growth stocks at any given time. If you can stomach 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 build wealth. It's not the only way, however. An income-generating portfolio built on high-quality divided-paying stocks can get the job done nicely as well.
It's true! Although dividends haven't historically (not recently, anyway) been viewed by investors as a primary means of getting rich, a bit of number crunching makes it clear that an exchange-traded fund like the ProShares S&P 500 Dividend Aristocrats® ETF (NYSEMKT: NOBL) is actually up to the task. (Dividend Aristocrats® is a registered trademark of Standard & Poor's Financial Services LLC.) There's just one catch.
But, first things first.
A Dividend Aristocrat® is simply the stock of an S&P 500 company that's raised its full-year dividend payment annually for at least 25 consecutive years. As of right now, over 60 such names qualify for the title, although most of them have been upping their annual payouts for far longer than 25 years.
Admittedly, the average yield here isn't exactly thrilling. ProShares says the fund's current dividend yield stands at only 2.3%, leaving some would-be investors wondering why this ETF should be seen as a long-term winner. Certainly, its ever-rising dividend payment helps, particularly when you reinvest those dividends in more shares of the ETF. Still, its long-term potential seems capped by its dividend-oriented focus.
The important detail not readily evident here is that stocks of companies with a policy of regularly raising their dividends -- and the capacity to make good on that policy -- actually do outperform most other stocks. Calculations performed by mutual fund company Hartford indicate that since 1973, stocks of companies that have reliably grown their dividend payments boast an average annual gain of 10.2%. For perspective, an equal-weighted version of the S&P 500 boasts a more modest average of 7.7%. Stocks that didn't pay dividends at all during this time only averaged a yearly gain of 4.3%. Hartford concludes that consistent dividend growers simply tend to be higher-quality, better-managed companies.
Oh, and the catch? The key here is just leaving such a position alone for years on end while reinvesting any of these dividend payments into more shares of the stock or fund paying them.
Avoid the ProShares UltraPro Short QQQ
Last but not least, most investors will want to avoid the ProShares UltraPro Short QQQ (NASDAQ: SQQQ) and other so-called "leveraged bear" ETFs like it. They just 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 a handful of ways, including the simple short sale of stocks found in a particular index. More often than not though, it's facilitated through index-based futures or options trades that serve as short-term bets on an index's direction. In the case of the ProShares UltraPro Short QQQ, the index in question is the aforementioned Nasdaq-100.
The ProShares bearish ETF is unique even by ETF standards in another way though. That is, it's also leveraged, meaning it rises and falls much more than the underlying Nasdaq-100 falls and rises. For every 1% the Nasdaq-100 dips, 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. A bit of well-timed exposure to a leveraged bearish fund like this one could at least offset the impact of a marketwide correction. It might even prove to be a major moneymaker ... if you plug into it at the beginning of the bear market.
These funds tend to be more trouble than they're worth and can easily do more harm than good.
See, the market's long-term tide is bullish even if it's occasionally interrupted by setbacks. Investors can afford to be patient, knowing the market and its highest-quality stocks will eventually recover.
That's not the case with bearish funds -- especially leveraged bearish funds. Not knowing if the stock market has made a major (or even minor) low until well after the fact means these ETFs can easily race deep into the red before you even start to think about cutting your losses. Never even mind the fact we tend to make bad decisions when we're stressed out or anxious!
The smart-money move, therefore, is simply not putting yourself into a position where you'd have to make such a difficult decision in the first place. Just be patient without trying to get cute or clever by doing something the vast majority of people -- including the professionals -- typically don't do well.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Microsoft, Nvidia, and ProShares Trust - ProShares S&P 500 Dividend Aristocrats ETF. The Motley Fool recommends Nasdaq and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
2 Index ETFs to Buy Hand Over Fist and 1 to Avoid was originally published by The Motley Fool