What makes QQQ the best ETF?

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Indexes
  1. The Loser’s Game
  2. Historical Performance of Active Investing
  3. Diversification of investment portfolio
  4. Why QQQ
  5. Return vs. Risk

The Loser’s Game

In the world of tennis, professional players score points by hitting aces, controlling drop points, and maximizing ball speed; however, for amateur tennis players, waiting for the same amateur to hit an errant ball is a more secure way to score points than scoring points by hitting good shots, because sunlight, wind speed, and the softness of the court can affect the amateur player’s performance. So if there are a lot of factors beyond your control in a game, keeping yourself in the game is the best way to win, and this is called a “loser’s game”.

Similarly, the stock market is also a loser’s game, because the market and human nature are unpredictable. When the black swan comes, no one can be prepared. So in the long run, a defensive investment strategy is better than an aggressive one. Therefore, the prerequisite for maximizing your return is to control risk.

Historical Performance of Active Investing

On Wall Street, the best way to demonstrate your superior talent is to have your annual returns beat the market. This is the only value of a professional manager, and few investors want to hear the words “we’re in line with the market”. Whether it’s a bull market or a bear market, if the manager underperforms the market over a few years, then the manager is likely to roll up and leave.

However, the reality is that few active funds have been able to beat the market in the last decade, either slightly underperforming in bull markets and outperforming in bear markets, or slightly underperforming in bull markets and spitting out their profits in bear markets.

The vast majority of fund managers end their careers with “out”, and the reason for this is that the investors who do not survive are not because they do not make enough money, but because in several bear markets, because of insufficient risk control, losing money and leaving the market. This risk comes from the risk of their own human nature, but also the risk brought about by a portfolio that is not diversified enough.

Diversification of investment portfolio

Many people think that “diversification” means buying a dozen stocks, but many people actually buy technology stocks that are still burning money. This is not diversification at all, but simply buying a dozen stocks in a same sector / type. When the market starts to care about P/E, or when technology stocks plunge, there will be large losses on the books.

Diversification involves investing in as many sectors as possible, and even in assets that move in different directions (such as bonds and gold), to ensure that you don’t put your eggs in the same basket. If you don’t like large fluctuations in your books, you should also invest in value stocks as appropriate. This way, your portfolio will not fall too much in bad times.

Why QQQ

As you can see from the QQQ portfolio, QQQ is a passive investment fund with 65% of its capital in technology stocks, while the SPY portfolio is much more stable, with a more even distribution of capital among stocks in various industries.

From a diversified portfolio perspective, SPY is clearly better than QQQ in terms of risk, but why would I invest in QQQ? If we look at the returns of QQQ, except for the tech bubble in 2000, QQQ has beaten SPY at all times; if we count from 2002, QQQ’s return is 4 times that of SPY.

So for QQQ, does high return mean high risk? Not according to the statistics over the last 20 years — whether on a 3, 5, or 10 year cycle, QQQ’s beta has remained below 1.05, while alpha has gotten higher (not necessarily a good thing).

Also for the recent past (May 2021), the SP500’s PE is actually higher than the NASDAQ100, which is not a good sign. The market may not realize that when they think technology stocks are overvalued and move to traditional cyclical sectors, it makes the SP500 shares overpriced instead. This is not a good sign, which means there is too much money in the market without a place to go, pushing up asset prices and causing the market to overheat.
QQQ has 45% of its assets in FAANG, so why not invest in it yourself?

Indeed, among the top tech stocks, there are some companies on the downhill (Intel, Netflix, etc.), which I would like to eliminate if I could. However, given the cost of my time and effort as an individual investor, it would be an impossible task to build up many positions and manage them in real time; and even if I did, I would definitely not do as well as QQQ.

The focus of QQQ is on the 65% of non-blue chips, which are located in other industries and provide some risk diversification to the portfolio, which is why QQQ’s beta has remained stable at below 1.05 for years while maintaining high returns.

Return vs. Risk

By the end of this article, I realized that it is quite difficult to find a balance between risk control and guaranteed return. On one hand, as a retail investor, I gave up investing in bond ETFs and SPYs to maximize my capital utilization; on the other hand, what I liked about QQQ was its stable portfolio.

Perhaps I was looking for its high return over a 10-year period and beta of less than 1.05. However, past data is not indicative of future risk. In a society where the prosperity of the service sector is based on the stability of the agricultural and manufacturing sectors. If a black swan appears one day and a major disaster occurs in the future, QQQ will be the fastest one to fall…