This will be fun.
We unearthed an article from our friends at Seeking Alpha.
Seeking Alpha is a platform that gives information to its readers about how to make money in stocks…
Namely, how to invest in stocks.
According to them, they are
Seeking Alpha is a platform for investment research, with broad coverage of stocks, asset classes, ETFs and investment strategy.
Great. What brought them to my attention was an article by one of their writers titled “Why You Shouldn’t Own DIA, SPY, or QQQ”.
Clearly they must be joking right?
For the rest of this article, I am going to go through piece by piece and tell you exactly what I think of it.
How To Make Money in Stocks…Without DIA? SPY? QQQ?
The author begins the article by writing:
Perhaps surprisingly, the three most popular ETFs – known as “Spiders” (ticker (NYSEARCA:SPY)), “Diamonds” (ticker (NYSEARCA:DIA)) and “Qs” or “Qubes” (ticker (NASDAQ:QQQ)) – are not in this portfolio. Here’s why.
Yes, that is surprising.
Alright, let’s dig in…
We have SPY, aka the S&P 500 index etf.
We have DIA, aka the Dow Jones Industrial Average index eft.
We have QQQ, aka the Nasdaq index etf.
When I think about these, I think about the fact that I trade all of them, almost every day (especially SPY and QQQ).
It would surprise me why this author would recommend those NOT be in the portfolio.
Before reading the rest of the article the only reason I could think of to not have these stocks in a portfolio is that they are ultra correlated to one another.
Remember correlation takes price movements of x amount of time and compares those price movements.
As we can see here, these index etf’s are very correlated to one another…
So maybe the author is saying not to have all of them in there at the same time?
Let’s see what he says.
SPY Index Fund
This author gets into SPY:
“Spiders” (SPY) are shares in an S&P 500 exchange traded index fund run by State Street, and are identical to an S&P 500 index ETF run by Barclays (NYSEARCA:IVV) but with a slightly higher annual expense ratio. Since our goal is to build a portfolio with the lowest possible annual expenses, we chose IVVs over SPYs. Traders tend to prefer SPYs due to their greater daily trading volume, and the fact that their slightly higher expenses don’t matter if they are held for only a short time. But for most investors, the increased liquidity of SPYs over IVVs is inconsequential, and you’re hoping to hold your portfolio for longer than a quick trade. Remember also that exchange traded funds cannot trade at a discount or premium to the underlying value of the stocks they track without inviting an institution to close the gap by exchanging the ETF for the underlying securities or visa versa, so lower liquidity should not impact the market value of IVV.
Let us compare SPY and IVV…
For starters…they are incredibly correlated so as far as price movement they are as close to the same thing as you are going to see.
Today is 1/5/2017…
SPY traded 78,379,012 shares.
IVV traded 2,970,122 shares.
Not even close…but what about the ability to hedge?
SPY has weekly options, traded 1,791,140 options contracts today, and has very tight liquid options markets:
IVV does not have weekly options, traded 210 options contracts today, and has markets you can drive the titanic through:
When I see statistics like this…
I assume there are no large funds or investors in IVV…
If there were, the liquidity would be much greater…
Meaning, more volume, more hedging (options contract volume), and more competition for orders (tighter markets).
And none of that is there…
Remember, the best traders in the world don’t gravitate to certain products by mistake.
While IVV does have a lower expense ratio (0.07% vs 0.09%) when compared to SPY, it is nowhere worth it (this is the authors reasoning for purchasing IVV over SPY).
Let’s break that down.
The savings in expense ratio on $10,000 of stock of IVV vs SPY is $20. If you ever want to hedge your position with options here, you will be giving that up and some having to pay up 30 or 40 cents per contract.
On top of that, with the lack of liquidity, you will have to pay above midprice for stock as well.
DIA Index Fund
Here is the speech about DIA:
“Diamonds” (DIA) are shares of the Dow Jones Industrial Average index fund. But the problem with the Dow is that it consists of only 30 stocks, so “Diamonds” fail to give us the diversification we require. In place of the Dow, we chose an ETF that tracks the S&P 500. A (perhaps more suitable) alternative would be an ETF that tracks the Russell 1000 index, as it’s broader than the S&P 500. What is clear, however, is that the Dow Industrials is a far too narrow index. Three blow-ups in the Dow would mean that 10% of your large cap portfolio gets hit.
First, the author’s problem with DIA.
The fact that it is only an aggregate of 30 stocks…
Hmmm…has he never bought or sold a single stock before?
I have an idea…since DIA is only 30 stocks let’s compare magnitude of move to something that has more stocks…
Like, for example, the S&P 500 which is comprised of 500 stocks.
We are going to look at the largest up and down moves in the Dow and S&P in 2016 and see if the Dow is more susceptible to larger drawdowns due to only being a basket of 30 stocks:
The largest up move in DIA in 2016 was on 1/29/2016 where the DIA went up $2.38 or 1.48%.
The largest up move in SPY in 2016 was on 3/1/2016 where SPY went up $2.43 or 1.27%.
The largest down move in DIA in 2016 was on 6/24/2016 where the DIA went down $-3.42 or -1.97%.
The largest down move in SPY in 2016 was on 6/24/2016 where the SPY went down $3.71 or -1.83%.
Hmmm…doesn’t seem like the magnitiude of the move for the 30 stock index (DIA) is any bit larger that a 500 stock index (SPY).
So much for being a problem with having 30 stocks as opposed to say…500.
The concept of holding something with 30 stocks being more “risky” than a stock with 500 stocks makes sense in theory…
But the numbers don’t lie.
QQQ Index Fund
Here’s this speech on QQQ:
“Qs” or “Qubes” (QQQ) are shares in an exchange traded fund tracking the top 100 stocks in the NASDAQ index, known as The NASDAQ 100. While broader than the Dow, the NASDAQ 100 is a slightly unusual index that makes its popularity baffling. It’s dominated by large capitalization technology stocks, but it’s not a pure technology index. In fact, it excludes some of the largest US technology stocks, such as IBM and HPQ, which are traded on the New York Stock Exchange. As a result, if you want to make a concentrated sector investment in technology stocks you’re better off buying the Technology Sector ETF, ticker (NYSEARCA:XLK).
The author suggests trading XLK, which is in his words “a concentrated sector investment in technology stocks”, more so than QQQ. Let’s see what he’s got!
For starters, QQQ and XLK move with a 97.08% correlation.
So while XLK may be more “concentrated” than QQQ, having names such as IBM and HPQ (ew) in its basket…it moves step by step with QQQ at a 97.08% rate.
In short, no difference.
But as we saw above, IVV was a terrible idea when compared to SPY. SPY simply had much greater liquidity (participation) thus, less risk. Let’s compare.
Today is 1/5/2017…
QQQ traded 24,071,105 shares.
XLK traded 8,750,635 shares.
QQQ has weekly options, traded 585,384 options contracts today, and has very tight liquid options markets:
XLK also had weekly options, traded 11,659 options contracts today, and has very tight liquid options markets:
While the author’s case for being more “concentrated” in the technology sector is not valid, XLK does prove to be a worthwhile product as it does have very reasonable liquidity (participation).
While I would always choose QQQ or XLK because there is just far more liquidity, XLK will do.
How to make money in stocks?
How to make money in the stock market?
The truth is…listen to people that have made a trade before. This author clearly has not.
Do not worry about something like expense ratios. They do not matter, especially when you have to pay overprice to buy or sell a stock. You end up losing on the deal.
It is always important to not solely trust the high-level concepts such as EFT concentration.
Looks at the underlying numbers, they do not lie.
Price movement does not lie. Liquidity does not lie.