First things first, let's define what we're talking about. When we refer to an ETF (not EFT), we're referring to an Exchange Traded Fund. An exchange-traded fund can be looked at as a basket of assets (shares/stocks, bonds, etc.). In other words, this might be a basket with 40 different stocks and you have the ability to purchase units of this ETF at a specific cost. The cost of the ETF goes up and down based on the performance of the 40 different stocks that are within it. Two benefits that I am a fan of are that ETFs often have low fees and it allows me to invest easily in a mixture of shares rather than purchasing all the shares individually.
One of the most popular ETFs tracks the performance of the S&P500. The S&P500 (Standard and Poor's 500) is a stock market index that tracks 500 publicly traded domestic companies in the United States. The S&P500 is the index, then there are various ETFs that track the index. Thanks to this, we're able to invest in the S&P500 in a low-cost and diversified manner through these ETFs. Now, there are lots of ETFs that track the S&P500 index, depending on different geo-locations, brokerages and the likes. At the end of the day, the ETFs usually perform in a very similar manner (at least the ones offered by well-established brokerages) so one doesn't need to be too concerned. With that being said, always look at the fees involved.
The three ETFs that I've found to be most popular are:
Let's break this down a bit further by looking at SPY (the top ETF in the table above and the ETF that I personally buy):
SPY currently trades at $409,59. This means that to buy 1 unit of this ETF, you will need $409.59. There are platforms that allow for fractional purchasing but that's a topic for another day. For your $409.59, you get 1 share of SPY but the question we want to look at is, what does that get us? In other words, what are the 500 companies? What is the weighting?
COMPANY | WEIGHTING |
Apple (AAPL) | 6.60% |
Microsoft (MSFT) | 5.83% |
Amazon (AMZN) | 3.01% |
Alphabet Class A (GOOGL) | 2.96% |
Tesla (TSLA) | 1.82% |
Alphabet Class C (GOOG) | 1.83% |
Berkshire Hathaway (BRK.B) | 1.66% |
Johnson & Johnson (JNJ) | 1.35% |
UnitedHealth Group (UNH) | 1.34% |
NVIDIA (NVDA) | 1.33% |
The weighing refers to the percentage of the company that the ETF holds. In other words, in the S&P500, 6.6% of the holding is in Apple and 3.01% is in Amazon. The purpose of this is to give you a good idea of which companies are within the basket so that you have an understanding of what you're investing in. This is important because there are many ETFs, there are ETFs that focus on financial companies, industrial companies, innovation companies and so the list goes on. It's important to do some research around an ETF and its holdings before blindly investing.
So, the question is, if we invested in the top 10 holdings (as per the table above), would we get a better return than actually buying the ETF directly and taking a piece of all 500 companies? It's a really great question and the way we figure this out is to look at the aggregate performance of the top 10 holdings versus the actual ETF itself over a period of time. Now, what happens in the past doesn't mean it'll happen in the future so we need to be careful to not make assumptions.
Let's look at the return over the last 10 years of these companies. We'll do this by assuming we bought $100 of each company roughly a decade ago and we want to see how much money we'd have in 2022:
COMPANY | ENDING AMOUNT |
Apple (AAPL) | $900 |
Microsoft (MSFT) | $1,100 |
Amazon (AMZN) | $970 |
Alphabet Class A (GOOGL) | $730 |
Tesla (TSLA) | $11,130 |
Alphabet Class C (GOOG) | $400 |
Berkshire Hathaway (BRK.B) | $380 |
Johnson & Johnson (JNJ) | $350 |
UnitedHealth Group (UNH) | $940 |
NVIDIA (NVDA) | $6,530 |
Disclaimer: These are rough returns, from June 2012 to the end of May 2022 using this stock return calculator.
So the total investment we $1,000 back in 2012 and 10 years later our portfolio would be worth $23,430 - That's quite an incredible return! Tesla and NVIDIA definitely pushed things up. Now, If you invested $1000 in the S&P 500 at the beginning of 2012, you would have about $3,895.52. This is a return on investment of 289.55%, or 14.06% per year.
We're looking at $23,430 versus $3,895 which is unbelievable.
Over the last 10 years and with the global pandemic, tech stocks really experienced incredible performance which is why those top 10 stocks show such an incredible return compared to the ETF and this is why we need to be careful about using the past to predict the future - we really shouldn't but this is still a really interesting experiment. Remember, the S&P500 ETF is a diversified vehicle that invests in a lot of market verticals and these verticals include a lot of companies that struggled during the pandemic, for example. But, that might not be how things go for the next 10 years, we might find that tech stocks (like in the top 10 above) don't perform nearly as well and therefore the comparison of top 10 against the ETF might be very different in the following 10 years ahead of us. And, let's be frank, a 14% return, on average, every year for the S&P500 is an amazing return!
Well, over the last 10 years, I've taken a bite from both sides. I own a handful of the companies directly (TSLA, GOOG, MSFT, and JNJ) but I also buy the S&P500 via the SPY ticker. So, I've seen some incredible returns from the direct share holdings but I've seen really good consistent returns from the S&P500. If I had been pushed to select only one, I would have bought the SPY and kept buying whenever I can. I'll be doing that for the years that lie ahead more so than buying individual stocks. That's purely my approach, you need to do your own research around what would work best for you, please.