Editor's note: Smart investing is about taking calculated risks. You can't avoid every possible problem. Still, you should be aware of what could go wrong... And sometimes, little-known risks are hiding in plain sight. Our corporate affiliates at Chaikin Analytics detail one of those pitfalls today...
Most of us wouldn't go into a casino and put down 30% of our money on the first hand...
But when you're "passive" about your investing, that's exactly what you're doing.
You see, many exchange-traded funds ("ETFs") are passive. You don't have to select the stocks yourself or worry about rebalancing. Instead, the ETF puts together the basket of stocks for you.
But as I'll explain today, these funds are less passive than they seem. In most cases, you're actually making an "active" bet on size and momentum. And that means you might not know how much risk you're taking on...
Many ETFs select their stocks based on a simple set of rules.
One of the easiest sets of rules is "market capitalization weighting." That's when the biggest stocks make up the largest share of an index or ETF's holdings.
This can lead to trouble for unwary investors, though...
For example, at the end of 2021, technology stocks made up nearly 30% of the market-cap-weighted S&P 500 Index. So if you only invested in an S&P 500-tracking ETF, like the SPDR S&P 500 Fund (SPY), tech stocks would have made up almost a third of your portfolio.
Maybe you didn't actively choose to be invested 30% in the tech sector. But that's the passive bet you made. And that proved dangerous when tech stocks sold off recently.
This kind of problem can pop up in other, less obvious ways...
Let's say you realize your portfolio is overweight tech giant Apple (AAPL). So you sell some AAPL shares to reduce your risk. You think you're in the clear, right?
If you're investing with passive accounts, your portfolio includes "sleeper agents"...
Check the holdings of your retirement accounts. If they hold a large percentage of the most popular ETFs, like SPY or other index-tracking funds, you could be overweight some big companies today. For example, here are SPY's top 10 holdings as of mid-February...
Just by investing in SPY, your portfolio has already inched you a lot closer to overweight Apple than you might've realized. So you could be taking on more risk than you want to.
Now, that isn't a bad bet to make if it works out. But it's important to understand that passive ETFs can lead you into highly concentrated bets on a small handful of companies.
You should be aware of that risk so you don't get surprised down the road. Make sure your accounts – including the "passive" ones – haven't led you into an active, oversized bet without you knowing it.
The bottom line is that you should always understand what bets you're making as an investor. After all... you never want to go in and throw 30% down on the first hand.
Editor's note: A wave of stock crashes has assailed the hard-earned wealth of everyday Americans. But recently, Wall Street legend Marc Chaikin alerted investors to a big threat that's coming next. His secret to predicting massive market shifts could have given you early warnings about the dot-com crash... the Great Recession... and the brutal tech sell-off we've seen this year. Click here to learn what he's saying now.
To the average investor, playing the stock market may feel like gambling. But it doesn't have to be that way... You can build your own investment plan and learn to stick with it, taking calculated risks instead of unnecessary ones. Read more here.
Individual investors need any advantage possible to keep up with today's uncertain market. And one of the most useful tools you can use to compete with Wall Street is high-quality data... Learn more here: The Exact Details of the Power Gauge.
NEW HIGHS OF NOTE LAST WEEK
AbbVie (ABBV)… pharmaceuticals
Bristol-Myers Squibb (BMY)… pharmaceuticals
Vertex Pharmaceuticals (VRTX)… pharmaceuticals
W.R. Berkley (WRB)… insurance
Brown & Brown (BRO)… insurance
Public Storage (PSA)… self-storage REIT
Costco Wholesale (COST)… membership-only stores
Hershey (HSY)… “Global Elite” chocolatier
Royal Gold (RGLD)… gold royalties
MP Materials (MP)… rare earth mining
Enterprise Products Partners (EPD)… oil and gas
Black Stone Minerals (BSM)… natural gas
Comstock Resources (CRK)… natural gas
Duke Energy (DUK)… utilities
Waste Connections (WCN)… trash and recycling
NEW LOWS OF NOTE LAST WEEK
James Hardie Industries (JHX)… home siding
Lennar (LEN)… homebuilder
NVR (NVR)… homebuilder
Home Depot (HD)… home-improvement products
Tempur Sealy (TPX)… mattresses
La-Z-Boy (LZB)… furniture
Whirlpool (WHR)… appliances
Camping World (CWH)… RVs and camping gear
Brunswick (BC)… boats