The Invesco QQQ Trust ETF (QQQ 0.63%), which tracks the Nasdaq-100, is one of the most popular ways for investors to get exposure to the often high-flying tech sector. Tech stocks account for the majority of the index's value.
Investors who held it in 2023 have been rewarded -- shares of the ETF have surged by more than 50% for the year. But those returns were largely driven by just a handful of stocks -- the "Magnificent Seven." Those tech giants are the largest U.S. companies today, and therefore hold outsized positions in the market-cap-weighted QQQ Trust, accounting for approximately 39% of the fund's total value.
And while there's a lot to like about the Magnificent Seven, there may be better opportunities for investors seeking market outperformance than buying shares of the Invesco QQQ Trust ETF. Here are three to consider first.
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1. QQQ's less expensive sister
If you're dead set on owning an index fund that tracks the Nasdaq-100 index, there's a better alternative for buy-and-hold investors.
In 2020, Invesco launched the Invesco Nasdaq 100 ETF (QQQM 0.65%). It follows the same trading rules as QQQ Trust, but its expense ratio is 5 basis points lower -- 0.15% versus 0.2%.
It may seem weird that Invesco decided to launch an ETF that competes with one of its most popular funds. But QQQ is an older ETF, and it has grown to over $200 billion in assets under management. Many shareholders may be sitting on big capital gains, locking them into the fund. Meanwhile, its size ensures adequate volume for traders looking to move in and out of the fund quickly without losing their trade to the bid-ask spread.
Therefore, Invesco can still make plenty of money by keeping its original QQQ Trust expense ratio at 0.2%. But to attract new investors, it needs to remain competitive with other fund issuers offering similar Nasdaq-100 index funds. The Invesco Nasdaq 100 ETF is its answer to the trend among its peers of ever-declining expense ratios.
The new Nasdaq 100 ETF is a better alternative for buy-and-hold investors looking to put new money to work in the stock market. While 5 basis points might not sound like much, there's no reason to leave money on the table.
2. Growth stocks with less of a premium
The phenomenal run of the biggest growth stocks in the market has pushed the valuation of the Nasdaq-100 index up significantly. The index has a price-to-earnings (P/E) ratio of 29.65 and a forward P/E of 28.49. A year ago, its P/E ratio was just 23.52.
Investors can find better values for growth stocks by looking beyond the biggest names. Small-cap growth stocks have gone unloved by the market in 2023.
The SPDR S&P 600 Small Cap Growth ETF (SLYG 0.39%) currently trades at a forward P/E ratio of just 15.3. That's nearly half the price of the Nasdaq-100.
Of course, small-cap growth stocks come with a lot more risk. There's a reason they've been beaten down by the market in 2023. Rising interest rates are especially hard on small-cap growth companies, which use debt to finance their growth. What's more, investors put a bigger discount on the present value of their hoped-for future earnings due to the higher rates available from risk-free assets in the market.
While small caps should trade at a discount to cash-rich large caps and megacaps in the current environment, they still look extremely cheap today. Their upside over the long run is much higher, as small caps can grow much faster than large caps. And you'll only pay an expense ratio of 0.15% for the SPDR S&P 600 Small Cap Growth ETF, compared to 0.2% for the QQQ Trust ETF.
3. Consider shifting to value
Value stocks have fallen out of favor in recent years, but this could be a great time to look to them as a way to diversify away from the large-cap growth stocks that have lately dominated the action in the market. Historically, small-cap value stocks have produced the best long-term returns for investors -- even better than small-cap growth stocks.
Despite the recent underperformance of small-cap value stocks, there are reasons to think the tide is turning. For one, the Federal Reserve has forecast that it will start cutting its benchmark interest rates in 2024, and there's growing optimism that it will cut them more quickly than previously expected, which would ease some of the pressure on small-cap companies. Moreover, small-cap value stocks right now are, relatively speaking, extremely good bargains.
What's more, because relatively few Wall Street analysts cover small-cap value stocks, there are more opportunities for active stock pickers to outperform the benchmark index. That makes an actively managed fund like the Avantis U.S. Small Cap Value ETF (AVUV -0.03%) a worthwhile addition to retail investors' portfolios. It trades today at a P/E ratio below 8, and its expense ratio is just 0.25%. While those fees are slightly higher than those charged by the Invesco QQQ Trust, the Avantis fund can help you diversify your stock holdings, and in theory should provide stronger returns for long-term buy-and-hold investors. That said, as an actively managed fund, there is potential for it to underperform its benchmark, the Russell 2000 Value index.
Considering the heavy concentration the Nasdaq-100 has in just a few massive companies right now, index fund investors may want to diversify their holdings into smaller companies. Those who would prefer to lean on growth stocks have several great small-cap fund options, but many investors may want to expand their holdings to include some small-cap value stocks at current prices as well.
Adam Levy has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
