Why You Shouldn't Own DIA, SPY Or QQQ

 |  Includes: DIA, IVV, ONEQ, QQQ, SPY, XLK
by: David Jackson

Perhaps surprisingly, the three most popular ETFs - known as “Spiders” (ticker (NYSEARCA:SPY)), “Diamonds” (ticker (NYSEARCA:DIA)) and “Qs” or "Qubes" (ticker (NASDAQ:QQQ)) - are not in this portfolio. Here’s why.

“Spiders” (SPY) are shares in an S&P 500 exchange traded index fund run by State Street, and are identical to an S&P 500 index ETF run by Barclays (NYSEARCA:IVV) but with a slightly higher annual expense ratio. Since our goal is to build a portfolio with the lowest possible annual expenses, we chose IVVs over SPYs. Traders tend to prefer SPYs due to their greater daily trading volume, and the fact that their slightly higher expenses don’t matter if they are held for only a short time. But for most investors, the increased liquidity of SPYs over IVVs is inconsequential, and you’re hoping to hold your portfolio for longer than a quick trade. Remember also that exchange traded funds cannot trade at a discount or premium to the underlying value of the stocks they track without inviting an institution to close the gap by exchanging the ETF for the underlying securities or visa versa, so lower liquidity should not impact the market value of IVV.

“Diamonds” (DIA) are shares of the Dow Jones Industrial Average index fund. But the problem with the Dow is that it consists of only 30 stocks, so “Diamonds” fail to give us the diversification we require. In place of the Dow, we chose an ETF that tracks the S&P 500. A (perhaps more suitable) alternative would be an ETF that tracks the Russell 1000 index, as it’s broader than the S&P 500. What is clear, however, is that the Dow Industrials is a far too narrow index. Three blow-ups in the Dow would mean that 10% of your large cap portfolio gets hit.

“Qs” or "Qubes" (QQQ) are shares in an exchange traded fund tracking the top 100 stocks in the NASDAQ index, known as The NASDAQ 100. While broader than the Dow, the NASDAQ 100 is a slightly unusual index that makes its popularity baffling. It’s dominated by large capitalization technology stocks, but it’s not a pure technology index. In fact, it excludes some of the largest US technology stocks, such as IBM and HPQ, which are traded on the New York Stock Exchange. As a result, if you want to make a concentrated sector investment in technology stocks you’re better off buying the Technology Sector ETF, ticker (NYSEARCA:XLK).

Moreover, many NASDAQ 100 stocks also appear in the S&P 500, so if you hold both QQQ and IVV (or SPY) you have significant overlap in your portfolio.

And finally, a more conceptual point: there seem to be many suitable criteria for inclusion in a stock index (such as market cap, industry sector, or growth/value), but which exchange the stock is traded on doesn’t seem to me to be one of them. QQQ, which tracks 100 stocks traded on the NASDAQ exchange, is thus a weird beast. And the same concerns apply to a more recent ETF (NASDAQ:ONEQ) which tracks all the stocks that trade on the NASDAQ.