Question from our mailbag: Which technology ETF is the better choice – TECL or XLK? – Victor in Kansas
It’s not surprising to see a high level of interest in the tech sector. Whether its the promise of cloud computing (NYSEARCA:SKYY), clean energy transportation (NYSEARCA:LIT), or improved cyber-security (NYSEARCA:HACK), technology always leads other sectors with arguably more innovation per square foot compared to everything else. But it’s also leading in terms of market performance and that’s why we’ve talked a lot about the technology sector at ETFguide Premium along with our weekly podcast.
Although the Direxion Daily Technology Bull 3x Shares ETF (NYSEARCA:TECL) and the Technology Select Sector SPDR ETF (NYSEARCA:XLK) both target the same sector (technology), the approach of each fund is radically different.
TECL uses triple daily leverage to tech stocks. That means if the tech sector is +1% on any given trading day, TECL should be up +3% or close to it. The opposite is true too. If the tech sector falls by -1%, TECL will fall three times more because it’s chief goal is to magnify performance returns.
Even without the leverage that TECL uses, the tech sector is extremely volatile and subject to wild swings. However, these potential shortcomings have been conquered by very strong market performance not just in 2018, but over the past several years.
While the broader U.S. stock market via the Schwab Total U.S. Stock Market ETF (NYSEARCA:SCHB) has climbed around +43% during the past three-years, TECL has soared almost +324%. Meanwhile, the Technology Select Sector SPDR ETF (NYSEARCA:XLK) – which offers un-leveraged exposure to S&P 500 technology stocks – has jumped an impressive +81% during that same time-frame.
Which ETF is better – TECL or XLK? The answer is that it depends on how you’ll be using the fund.
For example, if you want a short-term to intermediate term trade that aims for big short-term gains in a sector packed with bullish momentum, then TECL is an ideal choice. It’s always best to use leverage in a sharply trending market that’s moving in the exact same direction that you’re trading in.
On the other hand, if you’re investing with a longer-term view and you’re aiming to compound annual returns that have the potential to beat the longer-term performance of a plain vanilla index fund (NYSEARCA:VOO), XLK is worth looking at. Regardless, both TECL and XLK – because of their under-diversified nature – are best uses as complements to a diversified core portfolio that has exposure to the five major asset classes: stocks, bonds, commodities, real estate, and cash. Having a core and non-core portfolio along with a separate bucket called your “margin of safety” are the cornerstones of building an architecturally sound portfolio that we teach in our online classes.
By way of reminder, the S&P 500’s sector composition will change in September. Companies like AT&T, Alphabet, Facebook, Netflix, Twitter and others that were previously grouped together inside XLK are being re-classified into the Communications Select Sector SPDR ETF (NYSEARCA:XLC). XLC currently holds 26 companies, like the previously mentioned blue-chips, involved in telecommunications, media, wireless, along with entertainment and internet media. Meanwhile, XLK will continue its focus on pure-breed technology companies focused on software, semiconductors, and IT related services.
Looking ahead, nobody knows if the technology sector’s outperformance over the broader stock market will continue. But we do know that technology will continue to be an integral part of everyday life and more innovation is yet to come. This will open up new opportunities for enterprising companies and the chance for investors to participate in that growth via ETFs linked to these fast growing industry groups.
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