ETFs for investments

 This post is for knowledge sharing only. It is not intended to be investment or tax advice.

Highlight

There are a lot of ETFs on the market. Personally, I only prefer the following two ETFs for long term investments:

• VOO (or IVV):
• Both VOO and IVV passively track the well known S&P 500 index.
• The expense ratios of VOO and IVV are the same: 0.03%.
• SPY also tracks S&P 500 index but with a higher expense ratio: 0.0945%. It is more suitable for trading rather than buying and holding.
• QQQM (or QQQ):
• Both QQQM and QQQ passively track the Nasdaq 100 index. They are almost identical.
• QQQM is a newer ETF launched very recently for buying and holding. The expense ratio of QQQM is 0.15% while the expense ratio QQQ is 0.2%.

Notes on QQQM (or QQQ):

• Although QQQM concentrates heavily on tech companies, fundamentally it is NOT a sector ETF.
• For example, in the top 10 holdings of QQQM as of January 2024, we see the name of Costco Wholesale that belongs to the consumer discretionary sector.
• The only drawback to me is the expense ratio of QQQM is still too high, which is five times that of VOO. I keep searching for lower-cost QQQM alternatives, but so far have not found any satisfying one.

Why VOO

Here is my two-step reasoning, if not a proof, for why we should choose VOO:

1. Only Cap-Weighted Indexes

We invest low-cost index funds because we admit that we are not able to pick individual stocks. Instead we let the market select the winners for us. 

To achieve this, inspired by genetic algorithm, we can simply initialize a portfolio of stocks and then keep dynamically adjusting their percentages in the portfolio based on their performance on the market. We may also need to introduce new stocks to the portfolio or remove bad stocks. This is the spirit of passive investing: we don't try to predict which stock will perform better in future. Instead we passively respond to what the current market tells us.

Now in a free market, if we simply measure the success of a company by its market capitalization, the above passive investing idea requires to select funds that passively track some cap-weighted index, i.e. a stock index whose components are weighted by their market value. 

For example, both S&P 500 index and Nasdaq 100 index that VOO and QQQM track are cap-weighted indexes. This is a necessary condition to invest VOO and QQQM. 

Following this logic, one should NEVER invest any equal-weighted index funds. Such funds force each stock to be equal weighted, which is essentially penalizes good stocks during rebalance. Therefore, there should be no surprising that the performance of RSP, an S&P 500 equal weight ETF, is much worse than that of VOO.

2. Only Cap-Weighted Large-Cap Indexes 

Now for long term passive investing in cap-weighted index funds, it is totally OK or even better to only invest cap-weighted large-cap index funds without any exposure to small- and mid-cap companies.

For illustration, let's explain the above statement with a specific example in reality: 

• VOO is a cap-weighted large-cap ETF holding stocks of around 500 U.S. top large-cap companies. 
• VTI is a cap-weighted ETF that passively tracks CRSP U.S. total market index and holds around 3800 U.S. stocks across large, mid and small capitalizations.

The performance of VOO is better than that of VTI. The performance gap is larger over a longer time span. 

• The small- and mid-cap stocks in VTI not only lack the ability to significantly impact VTI due to their low weights, but also contribute to over-diversification, consequently diminishing overall returns.
• Investing early in a potential future star in VTI doesn't matter much because of its low weight. By the time it becomes influential in VTI, it'll likely have grown into a large-cap company and also end up in VOO.
• VTI might beat VOO in some year (like 2020) when small- and mid-cap stocks perform better than large-cap stocks overall. But this is NOT sustainable: If small- and mid-cap stocks continue to grow rapidly, they will eventually become large-cap stocks and be added to VOO as well.

Similarly, it is also NOT a good idea to invest cap-weighted small or mid-cap index funds (like IWM) for long term:

• True future stars in low-cap indexes only take a small weight.
• True future stars will be removed from low-cap index once they reach a certain size.

BTW:
People usually sell VOO at loss and immediately reinvest the proceeds in VTI for tax loss harvesting.

Why QQQM 

People may want to seek for a higher return than VOO by giving up some of the diversification provided by VOO.

For example, QQQM only picks100 of the largest non-financial companies listed on the Nasdaq Stock Market. There are also other selection criterions:

• Tech sector ETF like VGT (expense ratio 0.1%) or XLK (expense ratio 0.1%)
• Both VGT and XLK do not hold GOOG, META as well as AMZN.
• Assigning stocks to sectors is not objective. For sector balance, GOOG and META are assigned to the sector of communication services while AMZN is in the sector of consumer discretionary.
• Growth ETF like VUG (expense ratio 0.04%), VOOG (expense ratio 0.1%) or SCHG (expense ratio 0.04%)
• Roughly speaking, the growth here is from the view of financial metrics like EPS.
• I am still in understanding the details of the underlying growth indexes. 

Remarks:

• Historical returns of these ETFs in the past ten years are mainly determined by their underlying portions of the tech giant stocks.
• Although both QQQM and its alternative candidates beat VOO in the past ten years, theoretically there is no guarantee that it is sustainable: all future stars could not be listed in Nasdaq or in the tech sector.
• But I am still in figuring out whether all future stars can be ultimately included in growth ETFs as that in VOO.