You may be wondering what the best tech companies to invest in are and maybe even if you should have a part of your portfolio allocated specifically to tech stocks. As an index fund investor, you likely already own the best tech stocks, so before you double down on them, here's what you'll want to know.
Lately, I have been starting to see something that I haven't seen in over 20 years: people with a part of their asset allocation dedicated to tech stocks. Let me give you an example:
Some time in the mid to late 2000s, I read a ten-year-old book. The book was well-written and mostly very reasonable in its recommendations. And then I came to a point in the book where it gave a recommended asset allocation. The allocation included a 5% allocation to tech stocks and a 5% allocation to telecom stocks. I thought, “Hmmmm…..that's funny. Nobody recommends those sorts of tilts anymore. I wonder why?” Well, it doesn't take a genius to figure it out. The most common tech ETF back then was QQQ, which basically tracked the tech-heavy NASDAQ index. Let's take a look at it.
Well of course a 5% allocation to QQQ would be a great idea, right? I mean, look at that performance! But when I read the book, that wasn't the perspective I was looking at it from. I was looking at it from this perspective:
Very different picture, right? No one in their right mind would add a dedicated tech slice to their portfolio after seeing this. But now people are talking about it again. Why would that be? It couldn't just be performance chasing, could it?
I think it probably is. Obviously, it's tough to say something is a bubble until after the bubble bursts, but doubling down on something with recent strong past performance is generally a recipe for disaster. As Harry Truman said,
“There is nothing new in the world except the history you do not know.”
It's performance chasing at its finest. Just because you wish you had put all your money into tech stocks 5 years ago doesn't mean you should do so today.
Adding a Tech Stock Allocation to Your Investment Portfolio
So what does it do to your portfolio to add a tech allocation to it? Let's say you've got a portfolio that is currently 30% Total Stock Market and you're thinking about adding a 5% tech stock allocation to it. That 5% has to come from somewhere, so we'll assume you take it out of the Total Stock Market Fund and put it into the Tech Fund, let's use QQQ just for convenience, but you could easily substitute VGT or FNCMX for it. Let's look at the top holdings in the two funds by percentage:
Total Stock Market:
QQQ:
Well, that's weird. They look almost the same, don't they?
What Increasing the Tech Stock Allocation in Your Investment Portfolio Really Means
The first seven holdings above are exactly the same. The only difference is that they make up 19% of the Total Stock Market but 44% of QQQ. You already owned all of these top tech stocks. Now you just own more tech stocks. And you are buying them AFTER their excellent performance and AFTER they become super popular. Does that seem like a good idea to you?
So if you go from a portfolio that is 30% TSM to 25% TSM + 5% QQQ, what has really changed? You have essentially gone from the left to the right.
You now have a portfolio that is a little larger and a little growthier. That's it. You've basically doubled down on some large growth stocks comprised of tech companies that you already owned a whole bunch of. Take a look:
You now have 6.5% Apple stock instead of 5.3% Apple and 2% Facebook stock instead of 1.7% Facebook and 2% Tesla stock instead of 1.4% Tesla. Is that really what you were going for? Are you now more diversified or less diversified? In essence, all you're doing is betting that recent past performance is going to be indicative of future performance. That's such a bad idea that mutual funds are required by law to tell you it is a bad idea. Want a really sobering thought? Take a look at this list of the top holdings of the Total Stock Market from the end of June 2018, less than 3 years ago:
As you can see, you already own 50-100% more Apple, Microsoft, Amazon, and Google stock than you did 3 years ago. And now you want more? If you really want to add a QQQ tilt to your portfolio, the time to do so is NOT after a massive run-up. Anytime between 2003 and 2013 would have been fine though.
Get a Written Investing Plan and Limit Changes to Your Asset Allocation
You should probably ask yourself why you weren't interested in buying it then. Once you understand why, it will likely fix your desire to buy it now. You see, we as investors are hard-wired to chase performance. It is simply the way our brains work. You must do all you can to resist it. I have found that a written investing plan with a requirement to wait three months before making any asset allocation changes has done the trick for me. After three months have passed, I've usually forgotten about my crazy idea. And if not, then I go ahead and make the asset allocation change.
The bottom line is this: performance chasing is a serious risk to your long-term returns. A fixed asset allocation prevents performance chasing. Adding an asset class to your allocation should be done rarely, and not after a huge run-up in that asset class.
What do you think? Do you have a tech stock allocation? Would you add one now? Comment below!
Great illustrations of a really important point. It is 100% performance chasing. And it’s being done by the same investors who know they shouldn’t be doing it. Why? Because it’s hard to resist. Heck, QQQ was even the main sponsor of March Madness this year!
Like you said, get a written plan and follow it
Not to mention that since 1926, the top 10 stocks trailed the market by an average of 1.15% over the next decade.
https://youtu.be/foqswJT3Spc
I agree that performance chasing is detrimental to a portfolio, but a logarithmically scaled, inflation adjusted chart would be less chart crime.
Unfortunately, without the primary data I’m limited to what I can find out there. Feel free to produce and post links to better charts illustrating these points.
What was the name of the book and author that recommended the 5% in tech and telecoms?
Get Rich Slowly. Otherwise a great book and published years before many “Boglehead” classics.
But, this time is different, right?
I understand trying not to buy at the top but in theory wouldn’t adding a tilt to tech be the same as tilting toward SCV or Emerging markets? Taking more risk for potentially more return. I guess tilting to SCV is just more “accepted” with more historical data. I have actually been debating on tilting toward tech (5-10%) in QQQM and QQQJ so this post hit home for me. The only issue is who knows when the crash will happen or if the bull run will continue for x more years. I can’t time the market.
If you believe tech has higher long term returns, then sure. I’m not sure there is good data demonstrating that.
No it’s not. Academic research indicates there are several independent sources of return, market beta (the whole market), size and value to name the main ones. Large cap growth stocks are not among these factors, so it doesn’t make sense to tilt (or overweight) them. You are just decreasing the diversification of your portfolio (therefore increasing the risk and decreasing the expected return, on average) if you do. It does make sense to tilt towards know factors (SCV) or to emerging markets as with emerging markets you are diversifying geographically. For more on this check out Larry Swedroe’s book “Your complete guide to factor based investing”.
I understand what this post is getting at, but I think it is important to maintain our perspective.
In the “buy here/don’t buy here” chart towards the end of the post, you have the first “Don’t Buy Here” arrow pointed when the chart was at its peak, just prior to the year 2000. So what would have happened if someone HAD bought there?
Well, by 2020, they would have doubled their money, at about a 5% annualized return. And that’s if they NEVER rebalanced. In theory, if someone was really going to make the decision to add this tilt to their portfolio, they should be rebalancing all the way down that curve, buying at the top AND the bottom. This would have significantly increased their returns.
This is a concept I’ve been thinking about a lot lately in regards to cryptocurrencies. If one wants, say, 3% of their portfolio in crypto (as I do), I don’t think a historic bull run should discourage them from making that decision in buying crypto, as long as they intend to stick with it on the way down as well.
The question at the heart of this post isn’t if it is a good idea to have a technology tilt in one’s portfolio.
The real question is, once once decides to implement that tilt, can they stick with it?
Assuming the tilt in question is reasonable, and I would say most small tilts can be classified as “reasonable”, what will really determine if it was a successful move or not will be if the investor has the stomach to maintain that tilt in the good times and the bad.
I think you’re not accounting adequately for the fact that we as investors are far more likely to add a tilt AFTER it has done well. Take my own experience. When did I add a REIT tilt to my portfolio? The beginning of 2007. After a huge run up. Just before a huge crash. Have I maintained it? Yes. Has it still been a pretty good return? Yes. But it would have been a lot smarter to add it in 2009.
People really need to ask themselves whether they are performance chasing when adding asset classes to the portfolio.
It would have been smarter to add it at the bottom, sure.
But without having a functioning crystal ball, you took what information you had, thought about it for 3 months, and STILL decided that it was a worthwhile long-term addition to your portfolio.
And that’s the other key here: Presumably no one is going to add a tilt to their portfolio that they don’t think is worth holding for the long-term. And if it’s worth holding for the long-term, it’s worth buying it now, tomorrow, and in perpetuity.
Well articulated and good response.