Want to Invest in Tech Stocks With Less Risk? Try This Proven Strategy
After a tumultuous couple of weeks, the stock market is surging once again. The S&P 500 (SNPINDEX: ^GSPC) is up by more than 8% over the last three weeks alone, as of this writing, while the tech-heavy Nasdaq (NASDAQINDEX: ^IXIC) has soared by just under 10% in that time.
Tech stocks, in particular, tend to thrive when the market is on the up, and investing in the tech sector can be a fantastic way to generate wealth and beat the market.
That said, tech also tends to be riskier than many other industries, as these types of companies are often more volatile than their more established counterparts. It's critical, then, to invest carefully.
Fortunately, there's a way to invest in the tech sector that requires less research and carries less risk than buying individual stocks: investing in industry-specific ETFs.
What are industry-specific ETFs?
An ETF, or exchange-traded fund, is a basket of securities grouped together into a single investment. Invest in just one ETF, and you'll instantly own a stake in dozens or hundreds of stocks.
One of the biggest advantages of ETFs is that they're much easier to maintain than a portfolio full of individual stocks. Rather than studying 25 to 30 separate companies, you only need to research one or two ETFs for ample portfolio diversification.
While there are broad-market funds that include stocks from all areas of the market, industry-specific ETFs only contain stocks from particular sectors. By investing in a tech ETF, for example, you can gain exposure to hundreds of tech stocks within a single fund.
Can these ETFs beat the market?
ETFs, in general, offer less customization than individual stocks. You have no choice but to invest in every stock within the fund, so if there are lower-performing companies mixed in, that could bring down your returns. However, strong ETFs still have plenty of potential for above-average earnings.
For example, the Vanguard S&P 500 ETF (NYSEMKT: VOO) is a broad-market fund that tracks the S&P 500 index -- which is generally considered to be a strong benchmark of the overall market's performance. Over the last 10 years, this ETF has earned an average rate of return of 13.11% per year.
Now let's compare that to the Vanguard Information Technology ETF (NYSEMKT: VGT), a tech-focused ETF containing 318 stocks from various areas of the information technology industry. Over the past 10 years, this fund has earned an average rate of return of 20.63% per year.
Of course, there's more to consider when choosing an investment than just its annual returns. However, tech-specific ETFs have the potential to significantly outperform the market while limiting risk.
One big risk to consider before you buy
The primary risk with tech stocks, in general, is their increased level of volatility. While the tech sector often experiences faster gains when the market is thriving, it also tends to be hit harder during market downturns compared to many other industries. If you choose to invest in a tech ETF, be prepared for more severe ups and downs.
Because of the increased general risk that comes with tech stocks, it's extra important to ensure the rest of your portfolio is properly diversified. Even though a tech ETF will provide plenty of diversification within one industry, you'll need a wide variety of stocks from other industries, too.
Sometimes, achieving proper diversification can be as simple as investing in a broad-market ETF alongside a tech ETF. Broad-market funds like S&P 500 ETFs may earn lower returns than tech funds, but they can help minimize risk -- especially during periods of volatility.
Investing in industry-specific ETFs can be a smart way to gain exposure to a particular sector of the market with less effort than buying individual stocks. By understanding the risks and rewards with this particular investment (and ensuring your portfolio is properly diversified), you could be on your way to earning far higher-than-average returns while barely lifting a finger.
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Katie Brockman has positions in Vanguard S&P 500 ETF and Vanguard World Fund-Vanguard Information Technology ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
Want to Invest in Tech Stocks With Less Risk? Try This Proven Strategy was originally published by The Motley Fool