Avengers, S&P 500 Index and Exchange Traded Funds
If a massive alien army invaded New York City which Marvel hero would you pick to be on your team? Would it be Iron Man? Thor? Captain America? Hulk? Hawkeye? What if you could pick the entire Avengers Team? That would be the best option.
Well that’s what investors do when they buy Exchange Traded Funds (ETF) instead of individual stocks. ETFs are “Pooled funds that bundle anywhere from 100 to 3,000 stocks together to offer investors a diversified portfolio.” This is basically what mutual funds are but ETFs trade throughout the day on exchanges like a stock. You see the price fluctuations in real time.
If there was a Superhero ETF (if stocks were superheroes) it would include Avengers, Spider-man, Dr. Strange, Captain Marvel, Black Panther, Wolverine, Gambit, Daredevil, Deadpool, Luke Cage and the rest of the Marvel superheroes. It doesn’t stop there. You would also get heroes from the DC Comics universe: Batman, Superman, Wonder Woman, Aquaman,The Flash and Green Lantern. You get them all on one team. How could you lose?
ETFs have become quite popular over the past decade because they have lower fees than mutual funds (more on this later) and are more diversified than buying a single stock. Some ETFs pay dividends like regular stocks. The most popular ETFs closely track the S&P 500 index.
Standard & Poor's 500 Index is a market capitalization (how much a company is worth) weighted index of the 500 largest U.S. publicly traded companies. It is one of the most commonly followed indices by investors in the world because it is a benchmark for the entire U.S. stock market. Every hot shot investor or money manager wants to beat the S&P 500 index yet most under perform, especially over the long term.
If the Superhero ETF resembled the S&P 500 index we would have all the superheroes because they are based in the US except for Wolverine (Canada), Black Panther (Wakanda), Wonder Woman (Island nation of Themyscira) and Thor (Asgard). We will leave Superman (Kyptron) in this group because he grew up in Smallville, Kansas. Not all superheroes could be included in the fund, only the biggest. Jonah Hex (2010 film played by Josh Brolin), Steel (1997 film played by Shaquille O’Neal) and Howard the Duck (1986 film) would not be included. If you don’t remember these heroes or films that’s because they bombed big time. Literally no one went to see these movies.
Who invented ETFs? How did they get started?
Nathan Most was born on March 22, 1914 in Los Angeles, California. He was a physicist by training and worked as an engineer specializing in acoustics for the United States Navy during World War II. Later he spent years travelling throughout Asia selling acoustical material to movie theatres. He eventually went into Finance and started working for the Pacific Commodities Exchange.
During the 80’s and early 1990’s, mutual funds sales were booming but they couldn’t be traded like stocks. Nathan Most saw an opportunity during the 1987 stock market crash where U.S. markets fell more than 20% in a single day. He met with Jack Bogle, then head of the Vanguard Group. Most proposed using Vanguard’s 500 Index Fund in a new structure, one that would enable investors to trade the index fund, “all day long, in real time” like a stock.
Jack was not interested. Most was not discouraged and created the very first ETF listed in the United States: SPDR S&P 500 ETF (SPY). It began trading in 1993, the price was $45 a share and didn’t pay a dividend. It tracked the S&P 500 index. What was not anticipated was the interest in ETFs around the world. ETFs were starting to become a major rival to traditional mutual funds. Vanguard now has their own line of ETFs.
Today SPY is the largest ETF in the world with $300 billion in assets. It recently traded over $330 ($45 in 1993). The annual dividend is currently $5.73. The fund has achieved average annual returns of 9% since 1993. 9% a year compounded for 27 years really adds up. This fund has an expense ratio of just 0.09%. Most mutual funds charge between 2% and 3% and don’t generate the returns mentioned above. Mutual Funds employ a large number of skilled Finance/Investment managers and staff who research and trade stocks. ETFs like SPY basically use a computer program to track the index. That’s it. The fees on mutual funds really add up. A retirement portfolio of $500,000 would pay the following fees:
SPY $500,000 x 0.09% = $450 per year
US Equity or Index Mutual Fund $500,000 x 2% = $10,000 per year
You pay almost 22x more in fees with this mutual fund vs. the SPY ETF. With this one decision a person can retire years if not a decade sooner. That is how much fees impact your returns over the long term.
You can now see why billions of dollars around the world continue to move out of mutual funds and into ETFs. Today the global ETF industry has over $6 trillion of assets under management. In an ironic twist, Most never received a dime in royalties for the popular financial product he invented. He died in 2004, at the age of 90.
There are now over 2500 US Listed ETFs. There are even ETFs solely focused on video games, marijuana and how to profit off North America’s obesity problem. One ETF’s ticker symbol was SLIM and included stocks such as Weight Watchers, plus sized apparel makers and pharmaceuticals specializing in weight loss supplements & diabetes treatment. You could now profit off your obese neighbour who only wears XXXL clothing, regularly eats at McDonalds and needs expensive medications to manage his blood sugar levels. SLIM actually had great returns generating 35% in 2018, easily beating the index. The parent company suddenly closed the fund in early 2020. They didn’t provide any clarification. I think it was because of all the negative press they were getting. There is hope for humanity and maybe Wall Street. Maybe.
Companies in the S&P 500 index change with the times. Back in 2000, General Electric was the largest company in the S&P 500 index and the world. If General Electric stock was up for the year then so was the S&P 500 index. Today, it doesn't even rank in the top 100 of the S&P 500's most valuable companies.
In 2008 it was Exxon Mobil. Yes, an oil company was the biggest corporation in the index. Crude Oil was trading at $147 ($40 today) a barrel then and Exxon made a record $45 billion in profit. Profit is calculated by subtracting expenses from sales. $45 billion was left over after they paid for EVERYTHING including tips. Today the entire energy sector is only 3% of the index. Exxon Mobil stock is less than half of what it was in 2008. Fortunes can change fast. There is a reason people prefer to buy index funds instead of individual stocks, because if you are diversified then your investments are protected during a downturn in a sector or economy.
2019 was a great year for S&P 500 index investors, the index returned about 30%. Again, this is why S&P 500 index ETFs are popular. An annual return of 30% for buying an index with hardly any investment fees? Yes, but almost all the gains came from Apple, Microsoft, Amazon, Netflix, Google and Facebook. All of them are technology stocks: one sector of an economy. As of September 15, 2020 the technology sector hit a new high making up 29% of the S&P 500 index. Apple alone made up 7.5% of the index and is larger than several sectors such as energy and materials.
So much for diversification. If technology stocks above do well the entire index does well but if these six stocks drop the entire index falls. Someone should tell grandma about this.
If this was a US based Superhero ETF then Superman, Ironman, Batman, Spiderman, Captain America and Deadpool would be responsible for the majority of the gains even though there are hundreds of superheroes in the Marvel and DC universe.
If you want to stick to technology then it is best to buy a technology specific ETF. We bought QQQ, which trades on the Nasdaq stock exchange. The top 10 stocks in the fund based weightings are: Apple, Amazon, Microsoft, Facebook, Google, Tesla and Netflix. We have this in our portfolio because we want exposure to the fast growing technology sector but don’t want to take risk on individual stocks. Things move fast in technology, companies can rise or fall with each new product announcement. It’s not like toothpaste where Colgate Palmolive has pretty much owned the market for the past 100 years.
On January 1, 2010, QQQ was trading at $44 and paid a quarterly dividend of $0.36. Today the fund is worth $275 a share and the dividend is $1.68 a share. Those are incredible returns betting on a sector instead of a single stock. The ETFs give you upside and you are diversified.
When you buy ETFs it’s like getting almost all of the superheroes on your side instead of just one superhero. Anything can happen to one person but the team helps each other out. In the first Avengers film, Iron Man lost power in his suit after directing the nuclear missile at the alien fleet. He was falling from the sky at rapid speed and was sure to die on impact. It was Hulk who leaped up from a skyscraper and saved him. If the Avengers do go to war again with an invading alien army, it's probably best to sell your insurance stocks. You saw what happened to New York City the last time they went to battle.
