It's an exciting time to invest in tech stocks. Companies in the sector are innovating rapidly, and today, artificial intelligence (AI) is multiplying that pace exponentially.
There are several ways to benefit from the trend. You can buy single stocks like Nvidia or Amazon or try to find emerging tech stocks that could be the next Nvidia or Amazon. Having promising or established tech stocks as part of a diversified portfolio can lead to incredible gains.
Another approach is to find an excellent exchange-traded fund (ETF) that focuses on the tech sector. That takes away the guessing game of which stocks will be the winners and provides the benefits of investing in tech with lower risk. But not all tech ETFs are the same. Some concentrate on a small group of stocks while others follow broader indexes; some are riskier, and others invest in more-established tech winners.
If you're looking for an excellent ETF that offers steady and strong growth with low risk, here is one top fund to buy -- and one to avoid.
Buy: Vanguard Information Technology ETF
Vanguard has many ETFs that fit a variety of needs and risk levels. All of its ETFs are passively managed, which means that instead of hiring a manager to choose which stocks to include, the composition of the fund matches an index. That saves costs on the management side and gives investors the benefits of having a preselected and diversified portfolio.
The Vanguard Information Technology ETF (VGT -1.56%) tracks the MSCI U.S. Investable Market Information Technology 25/50 Index. Many of Vanguard's ETFs are considered low risk, but this ETF gets the highest rating for risk versus reward. It's a group of large-, medium-, and small-cap stocks, all in the tech sector.
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It has 314 stocks in its portfolio. That's highly diversified, which offsets some of the risks from owning stocks in a volatile sector. And because the composition is divided among various-sized companies, rather than focusing on big tech or emerging businesses, the risk is also more evenly distributed. However, it's weighted toward larger stocks, with Apple, Nvidia, and Microsoft accounting for 45% of the total.
Despite Vanguard's own high-risk rating, the tech ETF has performed quite steadily over the past five years. And because the risk is mitigated in a few ways, the fund has delivered strong gains. It's up more than 150% over the past five years, with an annualized five-year gain of 22%.
Because it's Vanguard, it also comes with a lower expense ratio of 0.10% as compared to the average of similar ETFs at 0.94%. This is great choice for investors looking to get in on tech sector gains while lowering their risk.
Avoid: ARK Innovation ETF
Cathie Wood has developed a reputation for investing in disruptive tech stocks that can revolutionize how the world runs. Wood loves digital, robotics, fintech, and other technology, and she has made some early calls about which stocks would explode, such as her favorite, Tesla, which she has bought through her investing firm, ARK Invest.
When the tech sector exploded with the acceleration of e-commerce and other digital technology at the start of the pandemic, so did ARK Invest's ETFs. But they haven't kept up throughout the subsequent market volatility.
Although their portfolios are full of disruptive tech stocks with tons of opportunity, they aren't highly diversified. The ARK Innovation ETF (ARKK -2.77%), which is the flagship ARK ETF focused on general tech disruption, has only 34 stocks. These are all high-risk tech stocks, with Tesla accounting for 15% of the total and Coinbase Global at 11%. That's putting most of your eggs in one basket.
The ARK Innovation ETF hasn't performed anywhere near as well as the Vanguard Tech ETF over the past five years.
ARKK annualized five-year price returns (daily); data by YCharts.
It might be worthwhile to follow Cathie Wood and see what companies she thinks are going to be the next big things. But if you're looking to maximize gains with exposure to tech stocks while keeping your risk low, the Vanguard Tech ETF looks like a better idea right now.
