NEW YORK (CNN/Money) - I'm 60 years old and need to re-invest $100,000 soon. I like the idea of a fund I can trade -- specifically, I'm interested in Qubes and Spiders. Is there a downside to these investments?
-- Linda Morris, Aurora, Colorado
You mean a downside other than the fact that with cryptic names like Qubes and Spiders many people haven't the slightest idea what these investments are?
Seriously, before I get into their possible downside, let me first explain what these investments are. Qubes and Spiders are both forms of ETFs, or exchange traded funds, which are essentially a type of portfolio of securities that you can trade just as you would an ordinary stock.
Qubes are a portfolio of the largest 100 non-financial stocks that trade on Nasdaq -- aka the Nasdaq 100 -- and get their moniker from the fact that their ticker symbol is QQQ. Since many of the largest companies listed with Nasdaq are tech firms, buying Qubes pretty much amounts to a bet on the tech sector.
Spiders, on the other hand, consist of the stocks that make up the Standard & Poor's 500, an index of 500 large companies that are typically the leaders in their industries. (For more on these and other ETFs, click here.)
Okay, now that we're all on the same page we can move on to the issue of possible downsides. As I see it, Qubes, Spiders and other ETFs have little in the way of any "inherent" downside -- that is, I see no significant risk in the way they operate or the way they're structured. They're designed to track certain indexes, such as the Nasdaq 100, the S&P 500, etc., and they do a good job of doing that.
But I do see a downside, and it's one that's highlighted by your question. You see, because Qubes, Spiders and other ETFs are so easy to trade, many investors have concluded that they should trade them. Apparently, they believe that buying and selling such indexes is a better way to superior long-term gains than simply buying an index and holding it.
Indexes are for holding, not trading
I think that's a big mistake, not mention a perversion of the original idea behind index investing (namely, that you can't outsmart the market, so you're better off buying and holding a broad market index). Once you start trading indexes like stocks, you begin eroding the power of indexing and, instead, you get into such dicey things as trying to figure out what index is likely to do better over the short term and which one to buy and which one to sell. And, of course, you begin driving up transaction costs. Both these things are a good way to lower your long-term performance.
But don't take my word for it. Check out the research that University of California professor Terrance Odean has done showing how higher levels of trading tends to lower investors' returns.
My advice: if you're going to invest in indexes, do it in a way that plays to the advantages of index funds and ETFs -- that is, their ability to provide low-cost diversified portfolios that harness the power of the overall market or particular sectors of the market. Otherwise, I think you'll find that the real downside in these investments is yourself.