Why SPY? The S&P 500 Is Not Everyone’s Benchmark

Why do investors bother with ETFs that are expensive and gimmicky when they could just buy funds like the iconic and popular SPDR S&P 500 Trust ETF (SPY)? As they say, despite the brevity of that question, there’s a lot to unpack there. So, let’s do that.

First, matching the S&P 500 is not everyone’s investment objective. While it may seem that way, since convincing investors of that is a growing sport, especially here in the United States, the fact is that by signing up for a portfolio that delivers market returns or close to it, an investor must accept a couple of things.

Based on its history, the S&P 500 has had years when it gained around 40%, and years when it lost around 40%. So, if an 80% range, top to bottom, is in an investor’s wheelhouse and comfort level, that might work for them.

SPY Versus Other ETFs: What’s Your Risk Tolerance?

Especially for younger investors who are in heavy savings mode, a high degree of market risk might sound like a dare they are willing to accept. But in setting one’s investment plan, investors need to double-check it before implementing it. Specifically, it's one thing to say you won’t change your attitude about seeing every $1,000 invested become $600 (or more like $450 based on the peak to trough declines that started in 2000 and 2007). But it's another to have buyer’s remorse once the excitement of markets like the current Nasdaq-infused runup fades. Investing is, if nothing else, cyclical.

And that is really the rationale for many ETFs that are not tied to the S&P 500 index, be they active, passive, thematic, hedged, or a market segment instead of representing “the market.” It's common for investors to look at an isolated return period and conclude that an ETF that has underperformed SPY is not useful.

I have many analogies I’ve used over the years to provide perspective to investors, but I’ll choose two here. First, if you are flipping through television channels and find a movie, watch for 10 seconds and then conclude that it is a horrible film and you won’t bother watching it, that’s a bit short-sighted, isn’t it? Yet that’s the equivalent of looking at an ETF over a shorter, fixed time frame and concluding that SPY is “better.”

The other analogy is one that may hit home with my friends and colleagues at etf.com’s New York City headquarters. Assuming that “SPY and chill” is the most sensible strategy, since it has outperformed so many ETFs over the past 12 months, is like going to a game at Yankee Stadium, seeing a guy strike out three times and going home thinking “that guy stinks.” Well, that guy might have been named Aaron Judge, who is on his way to another record-setting season in the pinstripes.

S&P 500's Recent Dominance Is Cyclical

And speaking of judge and judgement, that’s what investors should ensure they have enough of, following a time in market history where the S&P 500 has left many ETFs behind—because it is a market of stocks, as they say. And that means while semiconductors and software are roaring, this is not a permanent situation. Markets are cyclical if nothing else. And some investors, in fact many, may prefer not to “ride the wave” of mega cap tech indefinitely.

This goes right to the heart of what I am concerned will un-retire millions of baby boomers, my age peers. It is important to know what you own, and fully account for its risks, not only its past ability to boost investment account values. This is not about market forecasting. It is about creating awareness about the risk side of the equation, particularly when there are fewer years left to earn at a high level.

The oldest trick in the investing book is falling for what is currently popular, and assuming it is a fit for everyone, always. Particularly for “do it yourself” investors, this is why that label exists. Decide for yourself what range of returns you can accept and strive to understand how different types of ETFs fit that self-determined risk tolerance.