When I write these pieces, I try not to be too much of a homer. My daily musings are published here at Nasdaq.com, so it might be tempting to keep the boss on my side by writing the occasional nice thing about Nasdaq (editor’s note: No authors were harmed in the making of this article). But I try not to let that consideration influence my opinion. That is why I hesitated when I looked at the year’s performance of the major indices and realized that, despite how many times we’ve heard dire things about a tech selloff, the Nasdaq has led stocks up this year and has easily beaten the return on the Dow, among others. Was pointing that out being a homer, or was it legitimate information that investors can use?
I decided it was the latter, and here’s why: I worked for a while as a financial advisor, and the required training tells you that volatility in your clients’ portfolios is the enemy, something to be avoided wherever possible. That approach certainly makes your life easier as an advisor, but does it really help your clients?
If you look at the chart above, which compares the Nasdaq tracking ETF (QQQ) to its Dow equivalent (DIA), you can see two things. First, and most obviously, QQQ has gained 27% this year, versus the DIA’s 17%. Second, if you look at how that has been achieved, you will see that a lot of the swings, both up and down, have been exaggerated in QQQ as compared to the steadier, less volatile DIA.
In other words, if you stuck it out through the volatility, you made significantly more money this year with QQQ versus the DIA. “Okay,” some might say, “but this has been an exceptional year.” That is true, yes, but not in terms of outperformance by the more volatile QQQ. In fact, if we extend the comparison back to 1999, to account for the so-called “tech wreck” at the turn of the century, it becomes even more apparent, with QQQ returning way over double the Dow and S&P 500 equivalents.
The volatility in QQQ has been much greater throughout that time, but it has paid handsomely to endure it. And yet if you go to see a financial advisor, I can just about guarantee you that they will tell you that avoiding volatility is a good thing.
There are two reasons for that. The first is that, traditionally, people with enough money to invest with an advisor were nearly always on the older side, and as you get closer to whatever you are investing for, which is usually retirement, avoiding volatility is actually a good idea. Should the market turn down just before you are set to retire, you may be forced to change plans. So, giving up some long-term performance that won’t benefit you anyway in order to reduce the negative effects of volatility is a no brainer.
For an advisor, reducing volatility, even if it means sacrificing performance, makes sense when your clients skew older. However, now that increasing numbers of younger people are starting to invest, it makes less sense.
The second reason is a bit more cynical. Going by the chart above, an advisor that had advised caution in your equity holdings would have pointed out how wise they were at times of stress on stocks as your losses on those down moves were smaller than average. Then, over the twenty years or so, they would also point out that you had made a respectable 255%. What they wouldn’t say, of course, is that buying QQQ instead of DIA would have gained you 651%.
When markets pull back, which they inevitably do, clients get upset at you as an advisor, and blame you for their losses. If you can point to a below-average decline in a portfolio at that point, it saves a lot of grief. However, if you have added volatility in search of performance over time, a bigger pullback than average will prompt anger, maybe even a lawsuit. Lower returns over decades-long periods don’t help you as an investor, but they do make your advisor’s life easier.
What conclusions can we draw from all this? First, if you are a young person starting out on their investing journey, understand that when it comes to index ETFs, volatility is a short-term price you pay for long-term outperformance. If you are so fearful that short-term volatility will lead to you selling when stress builds, or if you are close to achieving your investing goals already, then take the safer path, but understand that you are giving up significant long-term gains.
As an investor, you will frequently be told that the key to success is to maximize returns while minimizing risk. That may be true in some circumstances, for example if you are in your sixties or older, or in individual stock investing where the downside to a bad investment is a 100% loss, but it isn’t true if you are buying an index fund for long-term holding. In that case, volatility is your friend, so buying the most volatile of the major index ETFs, QQQ, is the smart thing to do.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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