Investing in the right sectors is crucial when it comes to generating superior long-term returns for your portfolio, and the technology industry offers unparalleled opportunities for growth and innovation. No other sector has the same kind of dynamism in terms of creating new products with disruptive possibilities that the tech business provides.
However, competitive risks are always a challenge in such a dynamic sector; for this reason, investing in technology ETFs can provide a convenient alternative to capitalize on the industry´s growth potential while still keeping specific risks at bay thanks to the benefits of diversification.
Risk and Return in Technology
Warren Buffett is famously averse to investing in the tech business. The Oracle of Omaha has publicly stated that he doesn´t understand new technologies, and that´s why he stays away from the industry. Buffett likes to say things in a simple, unassuming manner, but there is some really profound wisdom in his words.
Buffett has been around long enough to see all kinds of promising technologies come and go through the decades. Investors in the tech industry can achieve amazing returns when positioned in the right companies: innovation is the ultimate driver of growth and profitability, and the tech industry is a particularly fertile ground for all kinds of ground-breaking products.
On the other hand, disruptive innovation can be a double edged sword as the winner of today can easily become the loser of tomorrow. At a company-specific level, the risks are always considerable when investing in the tech business.
Microsoft Corporation (NASDAQ:MSFT) used to be the undisputed leader in the industry a decade ago, when the company had a tremendously dominant position with its Windows operating system. This represented not only massive cash flows for investors, but also an enormously valuable strategic asset for the company.
But things change quickly in the tech business: the mobile revolution has been a big victory for Apple Inc. (NASDAQ:AAPL) and other companies, and Microsoft Corporation (NASDAQ:MSFT) is now in serious trouble as smartphones and tablets are gaining market share versus PCs and hurting Windows sales.
In a similar fashion, just when it looked like Apple Inc. (NASDAQ:AAPL) couldn’t do anything wrong, lower cost Android devices started rapidly gaining market share versus Apple Inc. (NASDAQ:AAPL) products in both smartphones and tablets. Investors in Apple Inc. (NASDAQ:AAPL) have seen the stock decline by more than 35% from its highs as growth has materially slowed down in the last quarters.
This doesn´t mean that completely avoiding the tech industry is the right thing to do, on the contrary, both Apple Inc. (NASDAQ:AAPL) and Microsoft Corporation (NASDAQ:MSFT) are still very profitable companies, and they are now trading at historically attractive valuations. If they manage to reignite growth via new and successful products, these tech titans could deliver big fat returns for shareholders in the middle term.
The same goes for other companies in the industry: trends like mobile, cloud computing, e-commerce and social networks, to name a few noteworthy examples, will provide enormous opportunities for growing profits over the years to come.
The point is that investing in individual companies is particularly risky in the tech business due to ever changing industry dynamics and an aggressive competitive landscape. Some investors may prefer a diversified approach to the sector by investing in ETFs as opposed to picking specific stocks in the industry. This provides lower upside potential when compared to finding the individual winners, but it also limits downside risks in case things don´t go as expected.
With almost $37 billion in assets, PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ) is the biggest and most popular tech ETF by a wide margin. The fund tracks the Nasdaq 100 Index, which represents the biggest 100 non-financial stocks in the Nasdaq Composite; in addition to heavy exposure to tech companies this ETF also includes some consumer discretionary and biotech companies in its portfolio. The expense ratio of 0.2% is quite reasonable, but still higher than the costs offered by competing products.
The low cost leader is Vanguard Information Technology ETF (NYSEARCA:VGT), which tracks the MSCI US Investable Market Information Technology Index. This ETF is smaller than its peers with $3.3 billion in assets under management, but it charges a lower expense ratio of 0.14%. The fund invests in a big portfolio of more than 400 companies but, just like the other two ETFs, it’s heavily concentrated among the biggest industry players.
The three ETFs are market-cap weighted, which means that giants like Apple Inc. (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT) and Google represent a big proportion of assets in the three cases.
The decision of going with ETFs or individual stocks should ultimately depend on aspects like the investor´s risk tolerance and general investment strategy among other things. For those who find individual tech companies too risky, but still want to invest in many of the most exciting growth stories of our time, technology ETFs represent a smart possibility to consider.
Andrés Cardenal owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Microsoft. Andrés is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article The Case for Investing in Technology ETFs originally appeared on Fool.com is written by Andrés Cardenal.
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