A Cheap Way to Own Tech Stocks

Vanguard Information Technology gives you access to the heavy hitters of the technology sector.

(Image credit: ijeab)

Scan the tech sector and you’ll see mamas, papas and rebellious young bucks. The elders, such as Interna­tional Business Machines, have grown sluggish in their old age, but their stocks look cheap and they pay hefty dividends. The kids, such as Facebook, are like rambunctious teenagers; they dominate hot new fields such as social media, but they are richly valued. Which ones should you go with?

Tech stocks can be notoriously erratic. Consider what has happened to the FANGs—Facebook, Amazon.com, Netflix and Google (now called Alphabet). They all soared last year. In the first nine months of 2016, Amazon and Facebook advanced smartly, but Alphabet climbed just 3.4% and Net­flix tumbled 13.8%. Meanwhile, lumbering IBM, with its 3.5% dividend yield, produced a total return of 18.4%.

Rather than trying to guess which tech stocks will fare best, investors can scoop up a wide variety in one ex­change-traded fund: Vanguard Information Technology (VGT). The ETF holds 377 tech stocks, from software makers to chip suppliers and internet firms. Because the fund weights stocks by market value, heavyweights play an outsize role. Apple, Microsoft, Facebook and Alphabet make up 38% of its assets. You may be surprised to learn that MasterCard and Visa are also among the top-10 holdings.

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Another surprise: The ETF excludes Amazon. It isn’t in the fund because MSCI, which supplies the fund’s benchmark, places Amazon in a retail-stock index with such firms as Home Depot. That’s too bad, because Amazon is one of the most dynamic internet companies (with a huge cloud-computing business), and investors in the ETF have missed out on the stock’s surge of 64% in the past year alone.

Also problematic: Smaller tech stocks hold little sway. Small and midsize firms account for 22% of the fund’s assets. Yet the ETF’s performance closely tracks that of Technol­ogy Select Sector SPDR Fund (XLK), which has just 9% in small and midsize firms, according to Morningstar. For more small-company exposure, go with Guggenheim S&P 500 Equal Weight Technology ETF (RYT) or PowerShares S&P Smallcap Informa­tion Technology Portfolio (PSCT).

Drawbacks aside, the Vanguard ETF makes sense if you want to get most of the big tech stocks in one package. Its 0.10% expense ratio is lower than that of any other tech ETF. And the fund has fared well, returning an annualized 10.3% over the past decade. That beat Standard & Poor’s 500-stock index by an average of 2.9 percentage points per year. Those extra returns don’t come without extra risk (remem­ber the dot-com bust?). But owning some tech stocks (old or new) should be a good long-term bet.

Daren Fonda
Senior Associate Editor, Kiplinger's Personal Finance
Daren joined Kiplinger in July 2015 after spending more than 20 years in New York City as a business and financial writer. He spent seven years at Time magazine and joined SmartMoney in 2007, where he wrote about investing and contributed car reviews to the magazine. Daren also worked as a writer in the fund industry for Janus Capital and Fidelity Investments and has been licensed as a Series 7 securities representative.