50% of the stocks in the S&P 500, generally referred to as the “stock market”, change every 10 years. We learn in Economics 101 that all companies go through a business cycle, yet the notion of the tax efficient buy-and-hold strategy is often referred to when buying single equities. That can be a big mistake.

If you inherited a portfolio of the top 3 companies in the USA in 1980 and thought it would be best to do what we do best, i.e. nothing, you’d be sitting with IBM (+3000%), AT&T (+600%) and Exxon (+2500%). You didn’t switch to NVIDIA, Meta and Microsoft, but you did rather well.

But, if you inherited a portfolio of 3 random companies, they would likely have already gone out of business. You would have lost all your money and the custody fees and withholding taxes would have chewed up most of your depreciated dividend dollars, if any.

McDonald’s is probably still serving BicMac’s at the same corner in your habitat, while smaller restaurant chains have come and gone with the wind. The stock market is no different. Holding on to small loosing positions in the hope of a turnaround is the biggest misinterpretation of the buy-and-hold strategy.

To a lot of people’s surprise, the index funds tracking the S&P 500, or the “market”, is actually actively managed and drops non-performing stocks from their capitalized weighted index quarterly. An example of this is the SPY (SPDR S&P 500 ETF Trust) managed by State Street.  500 stocks are bought or sold during the re-balancing. Not so passive if you ask me. 

Furthermore, when we compare an equally weighted index fund (each equity is 0,2% of the NAV) , such as the RSP (Invesco S&P 500 Eql Wght ETF) to the SPY (where the position size is relative to the market cap), the difference is substantial. The RSP expense ratio is 0,20% and the SPY expense ratio is 0,09%. The last five years the SPY has beaten the RSP with 40%. So when talking about the “market” and “passive” investing, don’t take it too literally. What is notable, is that the SPY allocation appears to be a very successful strategy. Similarly to having regular employee discussions  and getting rid of low performers and doling out bonuses to high performers, the selection process is brutal. But it’s actually a very common way to operate. You can see it also in high performing universities that have no entrance exam but 20% of students are dropped after the first year due to poor performance.

If the qualification process of the S&P500 is so good, wouldn’t the S&P100 be even better? I’m glad I asked. Historically, the S&P100, the S&P500 and the S&P1000 have all performed similarly. However, the best one has been the S&P100, then the S&P500 and lastly the S&P1000.

If we look closer at the top holdings of the SPY, we can see that they are all in the technology sector. The question arises if it would be better to zoom in on that sector? The popular technology ETF QQQ (Invesco QQQ Trust) has actually beaten the SPY with 67% the last five years.

If we are so certain that this trend will continue, why not utilize a leveraged ETF, such as the TQQQ (ProShares UltraPro QQQ)? It seeks daily investment results, before fees and expenses, that correspond to three times the daily performance of the Nasdaq-100 Index. The TQQQ has outperformed the QQQ with 42% the last five years and the SPXL has outperformed the SPY with 42% as well. The expense ratios are however out of this world. TQQQ is 0,98% compared to the 0,20% of the QQQ.

The leveraged ETF’s are more suited for short term investments. As the results show, the long term performance is not 3x.

Financial success doesn’t go unnoticed. Every year the inflow to index tracking investment vehicles is growing. The trend is strong and an obvious friend to the lazy investor. Since the S%P500 is a common benchmark for investment advisors and fund managers, they often invest directly or indirectly in it too (especially later in the year if their portfolio performance is ahead of the benchmark).

Internationally, when looking outside of the 10 biggest markets, passive investing can get even more dangerous. The smaller the companies, the bigger the risk.

Don’t be fooled by statistics of the stock market. The majority of all companies that have IPO’d the last 80 years, are already out of business. Buy blindly and you will be unknowingly applying the buy-and-mold strategy. Don’t trade unnecessarily, trade Vanilla Equity.

#BuyAndMold #BuyAndHold #SP500