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Diamonds and Spiders and Cubes, Oh My!
Linda Goin
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It seems every holiday season demands yet another rerun of "The Wizard of Oz." Every year for weeks after the movie I hear the incantation, "Lions and tigers and bears, oh my!" from my daughter when faced with situations that invoke fake fear (like cleaning her room). It doesn't stop there -- I've recently heard the chant in many office environments, too.
When I conduct research for this column, I often wish for a Wall Street Wizard -- a man with a megaphone calling out market mandates for my convenience. A pair of magic red shoes might decipher the way home, since there's no real magic within the financial district. However, stock indexes might come close to paving a yellow brick road for many who prefer the diversity of mutual funds to harboring individual stocks in their portfolios.
A few weeks ago we talked about how the National Association of Securities Dealers, Inc. (NASD) merged with the American Stock Exchange (AMEX) in 1998. The NASD assumed the role of parent company, but Amex still operates as an independent entity within the NASD family of companies. Five years before AMEX merged with NASD, they pioneered a product that combined stock trading with indexing. This product was called the Exchange Traded Funds (ETF), also known as Index Shares, and today they're running strong with folks who prefer the flexibility of these stock indexes to mutual funds. ETFs enable the investor to affordably purchase a group of leading companies in leading industries. They're very similar to mutual funds, except they trade throughout the day like regular stocks.
Although AMEX carries hundreds of ETFs, we're going to focus on the three most popular index stocks: the Dow-Jones Industrial Average (DIA), the S&P 500 Composite Stock Index (SPY), and the NASDAQ-100 Index (QQQ). They are also known, respectively, as Diamonds, Spiders, and Cubes (or Qubes), oh my! Hence, an easy way for my daughter to remember the names of the three most commonly exchanged ETFs. If you followed this column the past few weeks, you will recognize the names. Each one carries the benchmark companies and industries in their respective ETF.
If you follow the links above, you will land on an AMEX page detailing the statistics of each of the three ETFs. You will see the top ten companies within each one, as well as the industry groups represented, the fund details and objectives. AMEX retained the corner on these ETFs until August of this year, when the New York Stock Exchange (NYSE) also began to trade these three ETFs. You can also find these ETFs detailed at the NASDAQ site.
All these sites will advocate the advantages to ETFs. You can also find tons of online articles concerning the pro factors involved with investing in ETFs compared to buying mutual funds. I'll have to admit the upside far outweighs the downside with ETFs -- especially when we talk diversification. Outside of buying a mutual fund or individual stocks in every company listed in each ETF (did you win the lottery and lose your mind?), you won't find a better way to include such a wide variety of companies in your portfolio.
It's this diversity that keeps these three index stocks from running amok up and down the stock charts -- just like your own portfolio if you've diversified with a few varied industries. While some industries might be having a lousy month/day/year, other industries will temper this failure with their own successes. It also means that these index stocks often reflect the market more than individual stocks -- when the market is down, your individual stock might not feel the effect. Your index stock will probably feel the pinch.
There seems to be only one minor downside to buying ETFs for your portfolio. For example: if you buy ETFs with a budget of $25 per month, you might be able to purchase only a portion of a share each month. Compute your costs of brokerage fees -- no matter how small -- before you purchase through dollar cost averaging as it may not be worth the investment in the long run. It might be better to pick a few diversified companies and build your own index.
But, if you're a buy-and-hold long-term investor, anytime would be a good time to invest in any one of these three ETFs, especially if you're looking to shake that mutual fund. ETFs are more flexible than mutual funds, and often carry better tax advantages. Plus, you won't spend hours poring over annual reports to find the best companies for diversity. Just remember ETFs also maintain the same risks as any other investment, so you still need to do your homework to find the best fit for you and your portfolio. If you're still nervous, get on the horn to your tax advisor and ask them how ETFs might work into your upcoming investment year.
Speaking of portfolios and 2002 -- if you still haven't opened your account at BUYandHOLD, you might make this move a New Year's resolution. You won't be able to make an investment in a Diamond or Spider or Cube, oh my! or any other stock without an account. You don't have to be Dorothy to find your way home, either. Just go here to get started. My only advice is to involve your children -- they can be your best advocates for your foray into investing, provided they aren't flying monkeys from the castle of the wicked witch.
Have a safe and happy New Year, and Cora and I will see you next week.
Linda Goin
BUYandHOLD does not recommend any securities. The securities mentioned above are being used for informational purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy. |
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