Which Technology ETFs Are Best For Investors?

by: Daryl Montgomery


Technology stocks have offered almost double the returns of the S&P 500 in the last 10 years.

Some industry groups can offer even better returns than a broad-based ETF, but not always.

Performance among technology ETFs is compared for 10 years, three years and year-to-date in 2016.

Electronic technology (computer and communications hardware, software, services and platforms) has been one of the biggest growth areas in the economy for decades. The industry groups where the action is centered have shifted over time, of course, and will continue to do so in the future. Semiconductors and networking stocks were hot in the 1990s and then later in the decade Internet stocks became even hotter, forming a bubble that crashed the market. This caused the Nasdaq to drop close to 80% in two and a half years. Internet stocks remained important after the collapse, but the key players changed. Social media stocks didn't even appear until the 2010s.

Technology companies that last through the decades (and many do not) do so by reinventing themselves. IBM (NYSE:IBM) is the ultimate example of this, having developed the mainframe computer market in the 1960s long after it was founded and then segueing into a software and IT consulting company in the 1990s. More recently, Apple (NASDAQ:AAPL) transitioned from a microcomputer company, a technology it pioneered in the 1970s, to a smartphone company in the 2000s. Apple was in serious financial trouble in 1997, with Steve Jobs stating later on, "We were only 90 days away from bankruptcy." Nevertheless, Apple was the world's most valuable publicly-traded company in 2011. So, not only can the fortunes of technology industry groups ebb and flow, so can the fortunes of individual companies. This makes it critical to monitor relative performance in the sector.

Which technology ETFs are doing best depends on the time frame that is being analyzed. The best way to determine this is to compare performance to a broad-base ETF that represents the entire sector. Either IYW or XLK can be used, although IYW is a superior choice. XLK's top ten holdings include two telecom companies and Visa (NYSE:V), whereas IYW's are all standard tech companies. Investors can always just invest in IYM. In the last 10 years, IYM has outperformed the S&P 500 (NYSEARCA:SPY) by quite a bit. In the chart below IYM is the black line and SPY is the gold line. Tech is up almost twice as much as the U.S. stock market in general during this period.

Tech Stocks Versus General U.S. Stock Market, 10-Year Performance

Can an investor, though, do even better than IYW by buying an ETF representing a technology sub-sector? Usually, this is the case, but not always. Over a 10-year period, three ETFs: FDN, IGV and VGT outperformed IYW. FDN replicates the Dow Jones Internet Index. IGV replicates the S&P North American Technology-Software Index. VGT holds small, medium and large companies in the information technology group. VGT did only slight better than IYW. However, the difference for IGV, the gold line in the chart below and FDN, the blue line in the chart below, was significant over IYW, represented by the black line.

Top Performing Technology ETFs vs IYM in the Last 10 Years

The same ETFs also outperformed IYW in the last three years, as did one other, SOXX, which holds semiconductor stocks. Of the four, only FDN had a much higher return. The others, were not significantly better. FDN is the gold line in the chart below.

Top Performing Technology ETF vs IYM in the Last 3 Years

Since 2016 began, the picture is different. The best performing tech ETF so far this year is SKYY, which offers exposure to the cloud computing industry. Three of the other ETFs: VGT, IGV and SOXX, also did a little better than IYM, but in none of the cases is measurably important. The chart below shows how all the performances are jumbled together and there is essentially no divergence from IYM (the black line).

Top Performing Technology ETF in 2016 vs IYM Year-to-Date

The patterns of tech ETF performance indicate that tech investors currently are better off with a broad-based ETF such as IYW (XLK, IXN and IGM are other possibilities), since no single technology sub-sector is outperforming. The broader-based ETFs offer more diversification and therefore less risk and there's no reason to take on more risk because it is not resulting in greater returns as it should. The situation may be very different next year since longer term patterns in the sector may reemerge. The market will let us know.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.