1
$\begingroup$

Most financial advisors recommend to inexperienced investors to put a large part of their investment in broad index funds (e.g. SPY). They will usually reiterate that most actively managed funds underperform their benchmarks, that most day traders lose money, etc., in other words that beating the market is exceptionally hard and that therefore the inexperienced investor should not expect more than the CAGR of the S&P 500. But there are indices that have outperformed the S&P 500, e.g. the NASDAQ-100 (and the difference isn't small: CAGR 8% vs. 13% since the NASDAQ-100's inception). Prudent long-term investors should thus invest a large fraction of their money into a fund tracking those better-performing indices, e.g. QQQ.

But I rarely hear that recommendation. The assets under management of SPY are currently almost 2.5 times that of QQQ (and it was above 3x 3 years ago, when the outlook for QQQ was better). The most obvious counterargument to the recommendation is volatility, but I think this doesn't sound valid for a long-term investor. Since its inception, the NASDAQ-100 has gone through many downturns and it still outperformed the S&P 500 significantly. More importantly, the S&P 500 has gone through the same downturns (although not as pronounced), so this is not a strong argument in favour of the S&P 500. Similarly, I never hear a recommendation to put even a small fraction of your money into a leveraged fund like TQQQ (which even after this year's downturn has a CAGR of >30% since inception).

What am I missing? Is there something fundamentally wrong with QQQ, TQQQ and the like or are others just scared by the risk? The risk can be reduced by not throwing all your money at one asset, but compounding over a long investment time (I'm thinking of at least 30 years, i.e. from first salary to retirement) strongly suggests that at least one higher-performing asset should be in the portfolio.

Edit:

Some data: Given a 10-year investment horizon, the NASDAQ 100 underperformed the S&P 500 8% of the time, with the worst underperformance being 6.5% CAGR. Given a 20-year investment horizon, the NASDAQ 100 underperformed 0.75% of the time, with the worst being 0.7%. Given a 25-year investment horizon, it never underperformed.

$\endgroup$
5
  • 2
    $\begingroup$ Hi: When a financial advisor under-performs over a year, then, at the yearly performance review meeting with their client, they want to present the reason why as fluently and transparently as possible. What better excuse than: "you were invested in the broad market and, unfortunately, it underperformed because of X,Y and Z". Their goal is to keep clients and the best way to do that is to have a nice story when there is under-performance. Investing in those other indices won't provide as nice of a story during under-performance. $\endgroup$
    – mark leeds
    Commented Dec 31, 2022 at 2:19
  • $\begingroup$ I didn't mean just paid financial advisors, but all of them, including financial websites, bloggers, youtubers, etc. . Since I don't pay them directly, they don't need to find excuses for underperformance. Apart from that, for a 30-year investment, the performance in any particular one year is irrelevant, what matters is the long-term average. $\endgroup$ Commented Dec 31, 2022 at 3:49
  • 1
    $\begingroup$ The S&P 500 is more diversified, it contains many Nasdaq stocks but also many stocks that are not in QQQ. If you look at QQQ in 1999 2000 2001 you can see the disadvantage of investing in a somewhat narrow range of stocks like QQQ (it did very well, peaked, then crashed). macrotrends.net/1320/nasdaq-historical-chart Yes, it is risker. $\endgroup$
    – nbbo2
    Commented Dec 31, 2022 at 5:50
  • $\begingroup$ I know that QQQ is narrower, that's why I specified a long investment horizon. If you KNOW that you will invest for at least 30 years, it makes no sense to point at a couple of years of underperformance. A valid counterargument would have to show that QQQ underperformed for a long time period. I'll amend the question with some data. $\endgroup$ Commented Dec 31, 2022 at 7:35
  • 1
    $\begingroup$ To be more direct, the whole field of financial advising ( be it paid or not paid ) is kind of a whole lot of hocus pocus so I wouldn't put a lot of confidence in what any of them said. $\endgroup$
    – mark leeds
    Commented Dec 31, 2022 at 9:00

1 Answer 1

2
$\begingroup$

This is a question better suited for money stack exchange.

In any case, QQQ is the fifth largest ETF globally, not too bad for ~ 100 stocks.

Also, it seems there are a lot of discussions about what the best passive investment would be. QQQ is almost always in the list:

However, if you think of what the Nasdaq 100 is, you will come up with lots of reasons you should not consider this as your major passive investment vehicle. This morningstar article lists some. Essentially, if you want to be on the safe side, you do nott want to be in just one sector (you have no exposure to real estate, finance, energy and the like). Also, if most of passive investment would rely on ~100 stocks, I would say it's a very questionable "business model".

Yes, for a long time those large tech stocks did very well, but still, there is no guarantee that this will continue. With the benefit of hindsight, it would have been even better to just invest in the top 5 or so out of QQQ. Obviously, starting to try pick the better performing index, or sector etc is no longer passive investing.

With regards to TQQQ (any leveraged ETF). They are a lot more difficult to understand, and most layman do not know that due to daily rebalancing, leveraged ETFs will likely underperform the underlying during periods of volatility, even if the underlying itself rises. This is also called volatility decay and is best illustrated with a simple example. I will use Julia. Say we start with 100 and have two days. On the first day, we lose 1%. The next day we gain 1.02%. Therefore, we have an overall gain in the standard ETF. Yet, the leveraged ETF lost money.

start = 100
up = 0.0102
down = 0.01

function ETF(start, up, down, leverage) 
    return start*(1-down*leverage)*(1+up*leverage)
end
println("QQQ is worth $(ETF(start, up,down,1))")
println("TQQ is worth $(ETF(start, up,down,3))")

enter image description here

The larger the swings, the more likely it is that TQQQ will lose money, even if QQQ gains. Say we lost 10% on the first day, and gained 12% on the second. That is a nice gain on QQQ, but a hefty loss on TQQQ.

enter image description here

After all, there is a reason TQQQ has the following warning directly on the main page:

enter image description here

and there are news articles like Bloomberg: SEC may regret the day it allowed leveraged ETFs

In case you have access to Bloomberg, you can have a look at the following interesting news article: {NSN O7U8FS6TTDSX }

It is probably true that over 20 or 30 years, you may do well. Reality is that many people do not buy and hold for 30 years. Some may get some money as teenagers, that they want to use for university in two or 3 years. Others save for a house or appartment.

  • It is quite unpleasent if you lost ~ 20% last year. enter image description here


  • It is very annoying if you lost ~33% enter image description here


  • and mind boggling if you lost ~ 80% enter image description here.

If you planned to use your savings to buy a house in 2023, good luck! You probably end up selling before the market recovers - never again are able to afford a house, and get divorced after a year like this...

$\endgroup$

Not the answer you're looking for? Browse other questions tagged or ask your own question.