When given the advice to invest in a "broad stock market index" many people immediately think that means they should buy an ETF that follows the S&P 500 like the Vanguard S&P 500 ETF (VOO). After all, Warren Buffett is famous for telling his stockholders, "My regular recommendation has been a low-cost S&P 500 index fund." He put his money where his mouth was, too, when he made a million-dollar bet with hedge fund managers that, over 10 years, he could beat their results with an S&P 500 index fund--which he did.
But when you tune into your favorite financial channel, or check the front page of any investing site, including this one, the S&P 500 index is only one of the three major indexes that are always reported and give a minute by minute reading of the state of the market as a whole. The other two major indexes are the Nasdaq, which you can invest in via QQQ and the Dow.
The Dow is far from being a "broad market index" as it only holds 30 stocks. Most knowledgeable investors regard it as a relic of a simpler past that is reported only because of its historical importance. Though I have made a case that it is a pretty good proxy for the value and income segments of the market as a whole in a previous article, I would not recommend that an investor looking to buy a broad market index invest in a Dow ETF.
But what about the Nasdaq, which investors usually invest in via the Invesco QQQ Trust (NASDAQ:QQQ)? The Nasdaq is also a broad market index and one that has been outperforming the S&P 500 index dramatically over the past decade, as you can see in the chart below.
Source: Seeking Alpha
Though older investors will remember the Nasdaq's dramatic fall at the turn of this century, its dramatic rise before that collapse was strong enough that even with that collapse that it still equaled or outperformed the S&P 500 index at any time since its inception in 1971.
Source: Yahoo Finance
Though we are told not to chase performance, it's hard to argue with that kind of out-performance, especially when it rewarded investors so well. At least those who bought and held for the long-term, which is what we are also told we should do.
Looking at these charts you have to ask yourself why all the academics and most investment advisors continue to recommend that index-loving investors stick with low cost indexes that follow the S&P 500, rather than one that follows the Nasdaq. That is a question I have been asking myself, of late, too.
The ETFs that Track The S&P 500 and Nasdaq
You can't buy any of these indexes directly, you have to invest in a fund or ETF that tracks that index. The largest ETF that tracks the S&P 500 is the Vanguard S&P 500 ETF which has 243.7 billion dollars of assets under management. At first glance, this makes it sound like VOO is smaller than the SPDR S&P 500 ETF Trust (SPY), which also tracks the S&P 500 index and holds 397.27 billion dollars worth of assets. But VOO, it turns out, is actually just a share class of a Vanguard mutual fund, The Vanguard 500 Index Fund (VFIAX). The total assets of this Vanguard fund and ETF combination are a whopping 777.3 billion dollars. This is not as surprising when you remember that the Vanguard 500 Index Fund was the very first index tracking fund and has been gathering assets since it started trading in 1976.
The most common way to invest in the Nasdaq is via the Invesco QQQ Trust. Unlike VOO which invests in all the stocks in the S&P 500 index, QQQ invests only in the Nasdaq index's top 100 non-financial stocks, ignoring most of the other 3,000+ stocks in the full Nasdaq index. You can read more on the details about how QQQ works in my previous article which you can find here.
In the rest of this article, I am going to try to answer some of the questions you should be asking yourself in order to decide whether VOO or QQQ would be a better investment for you right now. Historical returns are wonderful, but only if you could go back in time to do your investing. Since Tesla has not yet come up with a working time machine, we have to think critically about those past returns in order to decide if there is a good chance they will continue to repeat the same patterns.
How Did Investors in These ETFs Do Investing at Previous Peaks?
The Dot.com Peak
Performance can be very different from what you see on graphs like those I showed you above depending on when your investment was made. Most working people scale into an investment, a bit every paycheck or two, which makes the returns shown on any chart with an arbitrary starting point misleading. Your own results can only be determined by putting your portfolio into a spreadsheet or other software tool.
But given that we are currently in a situation where both indexes are at all-time highs, many investors, including highly sophisticated professionals far more knowledgeable than I am, are holding their breaths waiting for the next big correction. Some are hoping that it is a correction and not a full fledged crash. So the obvious question to ask, when considering these two ETFs is what has been the experience of investors who bought into them at previous market peaks that were followed by serious downturns?
QQQ started trading in 1999. But the VOO ETF share class of Vanguard's 500 Index Fund did not begin trading until September of 2010, which is well after the two major market crashes that have occurred in the past two decades. Therefore, I am going to use the investors share class of the Vanguard 500 Index Fund (VFINX), which is just another share class of VOO, but was trading throughout the 1990s as a comparison to QQQ.
Total Return of QQQ and VFINX Since Dot.com Peak
Source: Seeking Alpha
As you can see, investors who bought into QQQ at the top of the Dot.com boom in 2000 have seriously under-performed those who bought the Vanguard 500 Index Fund at the same time. It took a very long 14 years for those QQQ investors to get back their original investment. That is a long, long time to hold any investment and it is likely most investors who did buy QQQ at its peak ended up taking heavy losses and moving on. Even now, the return of those who invested in QQQ at that peak and held still lags that of the S&P 500 fund. This explains pretty well why all those advisors, and Mr. Buffett, choose the S&P 500 over QQQ.
The Financial Crisis
From the above chart we see that the S&P 500 index fund dropped more in 2008 than did QQQ. This should be no surprise when you remember that QQQ excludes the financial stocks listed in the Nasdaq index and that crash was caused by a financial crisis.
So what happened to investors who invested in QQQ and VOO at the market peak that occurred before the 2008 Financial Crisis? (We are still looking at the mutual fund version of VOO here as VOO only started trading in 2010.)
Total Return of QQQ and VFINX Since the Pre-Financial Crisis Peak
Source: Seeking Alpha
Those investors made out like bandits. Those who invested in QQQ in 2008 came out way ahead.
The COVID-19 Flash Crash
Finally, let's look at what would happen if you invested in QQQ or VOO at the market peak that preceded last year's Covid-19 Flash Crash.
Total Return of QQQ and VOO Since the Pre-COVID-19 Peak
Source: Seeking Alpha
Here again we see that VOO dipped further and recovered more slowly than did QQQ during the COVID-19 crash. Clearly something had changed between the crash in 2000 and subsequent market crashes. To get a better idea of what explains this change we need to look more closely at the actual holdings of these two ETFs.
The Real Differences Between These Two ETFs
The most significant difference between the holdings of the two ETFs, beyond the fact that they track different indexes is that there are five times as many stocks in VOO. This is not quite as big a deal as it might sound. That's because both of these ETFs are Market Cap Weighted in a market that has seen the emergence of a small handful of super-companies, the Mega Cap stocks, with market caps far huger than that of most other companies worldwide.
The top 10 stocks in VOO make up 28.60% of its entire value. The top 10 stocks in QQQ make up 52.82% of its value. (Data as of July 31, 2021).
Source: Seeking Alpha and Vanguard.com
As you can see those top 10 stocks in both ETFs are almost identical. Of those top 10 stocks, only Berkshire Hathaway (BRK.A) is completely missing from QQQ. While PayPal (PYPL) and Adobe (ADBE) appear in QQQ's top 10 and not in VOO's, they are both still found just a few positions lower in VOO's list of holdings.
It's also worth pointing out that while most people think of QQQ as being a tech ETF, and attribute its out-performance over the past decade to it being heavy in tech stocks, it also holds quite a few stocks from non-tech sectors, too.
QQQ Holdings by Sector
Source: Seeking Alpha
You must keep in mind that the only factor that unites all the stocks in QQQ is that they all are listed on the Nasdaq instead of the NYSE or some other exchange. Since the Nasdaq is a younger index, the Nasdaq by definition excludes the stocks of the many long-established major U.S. companies that have been trading uninterrupted on the NYSE since before 1971. Until the last decade, listing a new stock on the Nasdaq exchange did not have the prestige that listing on the NYSE did, and it was cheaper to list a stock on it, too, so the Nasdaq got the reputation of being the place to find start ups, even though by now some of those start ups have become the FAANGM behemoths that now dominate both QQQ and VOO.
VOO Holds Only Profitable Companies
Another major difference between the two indexes is that an S&P committee curates the holdings of the 500 index and hence of VOO. It only selects from those companies that can show two sequential quarters of profits. There is no curation involved in selecting the holdings of QQQ. QQQ simply selects the top 100 stocks weighted by market cap present in the Nasdaq index. Thus there is no requirement that the stocks in QQQ, be profitable. This has allowed growth stocks like Amazon and Tesla that go for years or even decades without reporting any significant profits to play a huge role in QQQ's out-performance.
Though the collapse of QQQ in 2000 had a lot to do with how many companies in that index were earning eyeballs rather than dollars. The top stocks that make up slightly more than half of QQQ's value today are profitable and of far higher quality than the Dot-com darlings that dominated QQQ in 2000.
For today's investor, the difference between the two indexes is not so much quality, but that smaller number of stocks in QQQ give each stock held more impact. You end up with twice as much of the stocks held by both ETFs when you buy QQQ.
What Stocks Are in QQQ that Aren't in VOO?
Using a little spreadsheet magic, I matched the stock holdings of QQQ and VOO and came up with the list of the stocks that are in QQQ but not in VOO. Those stocks turn out to make up only 7.35% of the total value of QQQ.
This analysis is based on the stock weightings reported as of June 30, 2021, which were the ones available last week when I did it. The actual list of stocks held by the two ETFs have not changed since then, though the percentages might be very slightly different now than a month ago.
Stocks Held by QQQ But Not By VOO as of June 30, 2021
Source: List of All Portfolio Holdings downloaded from Invesco and Vanguard and Analyzed by the Author
The first thing that leaps out from this list is how small an impact most of these stocks have on the total value of QQQ. Only Moderna (MRNA) makes up more than 1% of the value of the ETF. There is almost 100 times more Apple (AAPL) in QQQ than there is Sirius XM (SIRI).
You can also see that while these stocks skew heavily towards tech and communications, Moderna, which is a health care stock is by far the most important. Most of these are recently listed companies that have not yet made a profit, but have attracted lots of growth investors. Remember there are another 3,400 or so stocks in the Nasdaq that are not in QQQ. It represents only the Nasdaq stocks that have attracted the most investors.
What is in VOO that is Not in QQQ?
Obviously, since there are 400 more stocks in the S&P 500 than in the Nasdaq 100. There are far too many stocks excluded from QQQ for us to list them all here. But given that market cap weighting also makes VOO top heavy, a lot of the companies that QQQ is missing out on make up only a tiny percentage, each, of the value of VOO.
Only 156 companies that are excluded from QQQ make up more than .10% each of the value of VOO. The rest of the excluded companies each make up such a small part of the total value of VOO that many of them would have to experience dramatic growth for them to contribute enough added value to VOO to make a difference in your returns.
Below is a list of the stocks each of which make up more than .25% of VOO which are not held in QQQ.
Stocks in VOO Excluded from QQQ
Source: List of All Portfolio Holdings downloaded from Invesco and Vanguard and Analyzed by the Author
As you can see, this list includes many fine stocks, including the biggest Financial, Retail, Consumer Staples, Manufacturing, Energy, Utility, and Pharmaceutical stocks.
Given that QQQ only holds stocks of companies that listed themselves on the relatively new Nasdaq exchange it, by design, excludes the stocks of these mostly older, fully mature companies, even though some, like Visa (V) and American Tower Corp (AMT) are very much involved with tech, and have been very generous to their stockholders. But there is definitely a skew towards older, mature, companies in VOO, many of whose stocks appeal to retirees and other dividend-oriented investors.
It would be easy to label many of these stocks "value stocks," as in the past that is just what many of them were. But as anyone who has spent any time looking at individual stock recently knows, the P/E ratios of many of what used to be value stocks have become extremely inflated, especially considering these mature companies' much slower rates of earnings growth.
QQQ, since it doesn't require that stocks come from companies earning profits, holds more growth stocks, and since it only picks the Nasdaq stocks most popular with investors, those growth stocks it holds are the ones that are currently growing. When a company whose stock is currently in QQQ stops growing earnings or something else causes its share prices to decline to where its market cap is no longer in the top 100 for a significant amount of time, they will be replaced by some other up and coming growth Nasdaq stock that has been climbing up through the ranks of Nasdaq's next 100 stocks by market cap weight. (The stocks ranked in the second 100 stocks by market cap weight in the Nasdaq can also be invested in, via a much newer and less popular ETF, the Invesco NASDAQ Next Gen 100 ETF (QQQJ).
There is another consideration when comparing VOO and QQQ. You will often see it cited by self-appointed media investing pundits that tech stocks (and by extension QQQ) will fall if interest rates rise because these companies need to borrow a lot of money to grow. But the very high debt/cap ratios of many of the mature stocks held only in VOO suggest that they, too, will find themselves strained by rising rates and costs, without, in many cases, having the kind of growth potential that could let them get by selling more stock. I don't see this as a reason to be wary of QQQ.
So Is VOO or QQQ the Better Buy?
I'm coming to think that you can only answer this question by spending some time poring over these lists of actual stock holdings. If you think that the non-financial mega-cap super-companies – the ones that dominate the top 10 holdings by weight of both ETFs – are likely to continue ruling the investing world, it makes more sense to invest in QQQ than VOO. Its smaller number of stocks gives more influence to each stock it holds and it holds a lot of those mega-caps.
But if you buy into QQQ, you should keep in mind that it is more of a growth stock popularity ETF than is VOO. Investors have been in love with growth stocks for quite a while, and for good reason – the ones now dominating QQQ have lived up to the dreams of those who invested in them a decade ago. But if future events should change the psychology of market investors dramatically, and investors suffer serious pain owning non-profitable growth stocks in the next major market downturn, there is always the possibility that QQQ could under-perform VOO.
Remember that the one big advantage that VOO has is that it isn't limited to listing stocks that appear on any one exchange. The committee that selects stocks for the S&P 500 index that VOO follows has much more latitude in picking stocks for the index. Their only limitation is that a stock be profitable and that it be a large cap stock. If the kinds of stocks now dominating QQQ do go out of favor, the S&P 500 can adapt far better than QQQ because it is not as limited in which stocks it can choose to hold.
This article was written by
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Though I have done quite a few different things over the course of a long life, I am best known as a writer of bestselling books about business and health. My success has come because I am a very curious person who doesn't just follow the herd and trust whatever the experts tell us to believe. I do my own research. I collect the facts, look at them objectively, and draw my own conclusions. Over the years, I have been amazed at how much of what everybody "knows to be true" is based on poorly designed studies, many of them impossible to replicate. I approach Investing with the same open mind, challenging the orthodoxies that attract the herd, studying how things really work, and doing my best to come up with an approach, based on facts, that works for me and would appeal to those who find thinking worthwhile.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Based on the information provided in the article, let's discuss the concepts mentioned:
Broad Stock Market Index
A broad stock market index refers to an index that represents a wide range of stocks from various sectors and industries. It provides a snapshot of the overall performance of the stock market as a whole. The article mentions three major indexes: the S&P 500, the Nasdaq, and the Dow. These indexes are often used as benchmarks to gauge the performance of the broader market.
S&P 500
The S&P 500 is a stock market index that includes 500 large-cap companies listed on U.S. stock exchanges. It is widely regarded as a benchmark for the overall performance of the U.S. stock market. The Vanguard S&P 500 ETF (VOO) is an exchange-traded fund that tracks the performance of the S&P 500 index.
Nasdaq
The Nasdaq is another major stock market index that primarily focuses on technology and growth-oriented companies. It includes more than 3,000 stocks listed on the Nasdaq exchange. The Invesco QQQ Trust (QQQ) is an ETF that tracks the performance of the Nasdaq-100 index, which consists of the 100 largest non-financial companies listed on the Nasdaq.
Dow
The Dow, also known as the Dow Jones Industrial Average (DJIA), is a stock market index that represents 30 large, publicly traded companies in the United States. It is often considered a barometer of the overall health of the stock market, although it is not as broad as the S&P 500 or the Nasdaq.
Historical Performance
The article discusses the historical performance of QQQ and VOO during different market peaks and downturns. It highlights that QQQ has outperformed the S&P 500 index (represented by VOO) over the past decade. However, it also mentions that past performance does not guarantee future results and that investors should consider various factors when making investment decisions.
Differences Between QQQ and VOO
The article points out several differences between QQQ and VOO. One significant difference is the number of stocks held by each ETF. VOO tracks the S&P 500, which includes 500 stocks, while QQQ tracks the Nasdaq-100, which includes 100 stocks. Additionally, the article mentions that QQQ includes more growth-oriented stocks, including those from the technology sector, while VOO includes a broader range of stocks, including mature companies from various sectors.
Stock Holdings
The article provides insights into the stock holdings of QQQ and VOO. It mentions that the top 10 stocks in both ETFs are similar, with some minor differences. QQQ's top holdings include tech giants like Apple, Microsoft, and Amazon, while VOO's holdings are more diversified across various sectors.
Profitability Requirement
Another difference highlighted in the article is that the S&P 500 index (and VOO) only includes companies that have shown two sequential quarters of profits. In contrast, QQQ does not have a profitability requirement, allowing it to include growth stocks that may not be profitable yet.
Considerations for Investors
The article suggests that investors should consider their investment goals, risk tolerance, and the current market environment when choosing between QQQ and VOO. It emphasizes the importance of analyzing the actual stock holdings of each ETF and understanding the potential risks and rewards associated with different investment strategies.
Please note that the information provided is based on the content of the article you shared. It's always a good idea to conduct further research and consult with a financial advisor before making any investment decisions.
