Navigating QQQ Risks: A Guide for Investors

Navigating QQQ risks

As a QQQ investor, it is important to understand the risks associated with this ETF. While I believe that the QQQ will outperform the S&P 500 over time, the objective of the fund does create risks if certain situations arise. In this overview of QQQ risks, I will highlight the things you should know, as well as some strategies for mitigating the potential risks .

About the QQQ

The QQQ ETF, also known as the Invesco QQQ Trust, is an exchange-traded fund that tracks the performance of the Nasdaq-100 Index. This index is made up of the 100 largest non-financial companies listed on the Nasdaq stock exchange. The QQQ provides investors with exposure to some of the most innovative and fast-growing companies in the technology, healthcare, and consumer goods sectors. It is a market-cap weighted index, so the Top 10 companies by market cap make up over 50% of the fund's holdings.

Market Risks

As with any investment in equities, there is a baseline of risk that comes with the uncertainty of the stock market. While historical data tells us that the market generally goes up over time, there are periods of time when stocks produce a negative return. The QQQ is subject to the ups and downs of the stock market, which can lead to fluctuations in the fund's value.

When it comes to broad market fluctuations, growth and tech stocks typically rise and fall at a more pronounced rate than the total market. During bull markets, it is not uncommon to see the QQQ outperform the S&P 500 by multiple percentage points. On the flip side, though, during a bear market, the inverse typically occurs. A couple years ago, the QQQ fell -33% while the S&P 500 fell -20%.

Understanding that the QQQ has the potential to outperform the total stock market in good times is a key selling point for many investors. However, it is important to understand the downside risk during risk-off markets.

Diversification Risks

Because the QQQ limits itself to holding 100 Nasdaq stocks, it should not be considered a diversified ETF by itself. There are several sectors that are underrepresented in the fund, including financials, energy, utilities, and industrials.

If the market enters a phase where investors favor sectors such as energy and utilities, you should expect the QQQ to underperform the market average. This was the case in 2022, when oil stocks had a strong year but the QQQ lost over 33% of its value.

As of 2024, the top sector weightings for the QQQ stand at 49% technology, 16% communication services, and 15% consumer discretionary. All 3 of these sectors tend to outperform in a strong economy but then lag the market in a weaker economy.

Individual Risk Tolerance

The most common investing mistakes revolve around buying a stock at its peak, selling it at the bottom, or not holding a stock long enough to see the hypothesis play out. This scenario is often starts with investor impatience or fear. Every investor should assess their risk tolerance before buying into the QQQ. Studying the fund's historical ebbs and flows will help you understand if this ETF is a good fit for your risk tolerance level.

As with many investments, the goal is to buy low and sell high. It sounds easy until you see your investment crash during a bear market. If you don't have the tolerance to buy more during the low periods, then it is unlikely you will reap the maximum rewards when things eventually turnaround.

Managing QQQ Risks

Despite the risks associated with QQQ ETF, there are several things investors can do to manage those risks. The most simple strategy is diversification. Investing only in the QQQ leaves you open to the risk of a tech stock downturn. By adding additional exposure to the sectors not covered in the QQQ, you can lower the risk of one sector dragging down your entire portfolio.

Another simple risk management strategy is to keep an appropriate level of cash in your account at all times. This gives you the opportunity to buy shares of QQQ during bear markets when the prices are lower. It also allows you to withdraw funds without selling your shares at their lowest points.

Stop-loss orders are another tool you can use to prevent outsized losses. These orders allow investors to set a predetermined price at which they will sell their QQQ shares if the price falls below a certain level.

You can also manage risk by buying and selling QQQ options. Options give investors the right, but not the obligation, to buy or sell shares of a stock at a predetermined price. By using options, investors can protect themselves against the downside risk of QQQ while still maintaining the potential for upside gains.

QQQ Risk Levels

Seeking Alpha currently assigns a risk level of C+ to the Invesco QQQ ETF. The primary factor in this average grade is the fund's standard deviation of 15 vs the median of all ETFs at 15. The standard deviation shows the degree to which an ETF actual returns vary from its average returns over a certain time period. In the case of the QQQ, the annual returns were quite choppy from 2019-2022 due to COVID impacts on the economy.

QQQ risk level from Seeking Alpha

Another key factor in Seeking Alpha's risk grade is the short interest of a stock. The median ETF has less than 1% of its outstanding shares being shorted. In the first part of 2024, the QQQ has over 15% of its shares being sold short. A lot of this has to do with the current volatility in the stock market and the fact that QQQ has an extremely high level daily volume.

Is the QQQ Right for You?

Understanding the risks associated with the QQQ is a crucial step before investing in this ETF. While this article lists several risks that may deter some investors, the QQQ's historical performance makes a strong case for adding it to your portfolio. The key is to make informed investment decisions and mitigate the impact of market volatility on your portfolio. By remaining aware of your risk tolerance and utilizing diversification strategies, it is quite possible to navigate the risks of the QQQ and use it to achieve your investment goals.