Millions of investors who think they have a diversified investment portfolio actually don't. Instead, they have dangerously concentrated positions in just a handful of stocks -- and a big problem in any of those stocks could spell disaster for their life savings.
But a new exchange-traded fund is trying to change all that. By focusing less on the biggest stocks in its target universe, it gives you exposure to some of the most promising winners in the market -- stocks that you wouldn't want to miss out on.
Lately, one of the hottest places to invest has been in tech stocks. Nowhere can you find a greater concentration of tech stocks than in the Nasdaq 100 Index, which includes the 100 biggest nonfinancial companies listed on the Nasdaq exchange. Not every company in the Nasdaq 100 is a tech stock, but most of the largest constituents of the index owe their success to technology.
But just because a company is big doesn't mean it has performed well. Apple is a notable exception to that rule, as the stock has jumped sixfold in the past five years despite having already been a mega-cap stock back in early 2007. But many of the other big stocks in the Nasdaq have performed either in line with the overall index or lagged behind its five-year return.
It's easy to invest in the Nasdaq 100, but the problem with doing so is that a small set of the biggest companies in the index make up a huge percentage of your investment. Just seven stocks are responsible for half of the Nasdaq 100's weight, leaving the other 93 stocks to fight it out for the rest of the pie.
That's where the Direxion Nasdaq-100 Equal Weighted Index ETF comes in. With the goal of matching an index that gives all 100 companies in the index the same influence on your return, the ETF owns no more of Apple than it does its smallest peers in the Nasdaq 100.
The nice thing about the Direxion ETF is that you have more exposure to the strong stocks near the bottom of the performance list. For instance:
Netflix (NAS: NFLX) has plunged in the past year, but it's still up more than 400% in the past five years, crushing the market's overall return. Despite new competition from many directions, Netflix at current price levels has a lot more room to run than it did last summer, with shares roughly triple where they stand currently.
Fossil (NAS: FOSL) has similarly quintupled in value since 2007. Even though it recently gave investors discouraging guidance for the coming quarter, Fossil's big expansion plans have shareholders excited about its longer-term prospects.
Green Mountain Coffee Roasters (NAS: GMCR) has many skeptics wondering what it will do for an encore, now that Starbucks has announced its plans to go head-to-head with the single-serve coffee specialist's Keurig machine. But even after a 1,000%+ gain, the company is small enough that a bigger competitor could snap it up in a heartbeat -- and meanwhile, sales of its products are still strong.
Perrigo (NAS: PRGO) has jumped onto the generic drug bandwagon with a vengeance. As major pharma companies see some of their biggest blockbuster drugs lose patent protection, Perrigo stands to get its fair share of the generic windfall that will result.
Dollar Tree (NAS: DLTR) is about as far from a tech stock as you can get, but its returns are nothing to scoff at. With a weak economy still shunting shoppers toward lower-cost purchases, Dollar Tree continues to take advantage of an ongoing trend -- one that sees little sign of reversing itself in the near future.
In a traditional Nasdaq-oriented fund, you'd have only fractions of a percent of your money invested in these stocks. But with an equal-weight ETF, they'd make up fully 5% of your portfolio.
Over time, smaller stocks tend to outperform their larger counterparts, albeit with higher risk. Equal-weight ETFs take advantage of that fact. If you have a long enough time horizon to hold on through entire market cycles, then a low-cost alternative like the Direxion ETF could well give you a better chance of owning meaningful amounts of tomorrow's big winners -- winners that conventional ETF investors will miss out on.
For true diversification, you need to go beyond the Nasdaq. The Motley Fool's latest special report on retirement delivers three promising stock picks for long-term investors. It won't cost you a thing, but don't wait; get your free report today while it's still available.
At the time thisarticle was published Fool contributor Dan Caplinger likes giving good stocks equal weight. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Apple, Fossil, and Starbucks. Motley Fool newsletter services have recommended buying shares of Starbucks, Apple, Green Mountain, Netflix, and Fossil, as well as creating a bull call spread position in Apple, writing covered calls on Starbucks, creating a lurking gator position in Green Mountain, and shorting Fossil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy doesn't let you miss out on anything.
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