When tracking the US stock market, you’ll usually see quotes from 3 major indices: the Dow Jones Industrial Average, the S&P 500 and the NASDAQ Composite Index. All 3 are proxies for US stock market performance, but they don’t always share the same components and weigh their stocks differently. The NASDAQ is the newest of the major indices, composed of the tech-heavy companies trading on the NASDAQ exchange. Confused yet? Read on to learn more about the difference between the NASDAQ exchange and the NASDAQ Composite Index and how to invest in its component securities.
The NASDAQ exchange was one of the first marketplaces to eschew a trading floor in favor of a fully electronic system. Traders could buy and sell stocks through a digital network, which increased speed and reduced bid/ask spreads. Today, all exchanges operate using computers, and traders can move stocks with a few smartphone taps. However, the NASDAQ is still an essential cog in global markets, and investors should be aware of the different securities based on it.
What Is Nasdaq?
NASDAQ is an acronym for National Association of Securities Dealers Automated Quotes, named after the organization that designed it. The NASDAQ exchange is the global electronic marketplace launched in 1971, but the NASDAQ Composite Index is a market cap-weighted index composed of the companies trading on the exchange. NASDAQ is known for its tech concentration, but there are over 2,500 stocks on the exchange in sectors ranging from finance to consumer staples to healthcare.
For inclusion in the NASDAQ Composite Index, a security must meet the following requirements:
- Exclusively listed on the NASDAQ exchange. Note that if a company was listed on another exchange before 2004, it could be included in the Composoite as long as it maintains its previous exchange listing.
- Must be a common stock, ordinary share, American Depository Receipt (ADR), Share of Beneficial Interest, Real Estate Investment Trust (REIT) or limited partnership to be considered for inclusion. ETFs, ETNs or preferred stock cannot be included.
Ways to Invest in Nasdaq
Buying all 2,500+ stocks in the NASDAQ Composite would stretch your portfolio thin. Thankfully, investors and fund companies have been getting NASDAQ exposure through more conventional means since the Dot Com Boom. Here are 3 easy paths to invest in NASDAQ:
Direct Stock Purchases
One method of NASDAQ investing is to concentrate your portfolio into a smaller assortment of stocks through direct purchases. Investing in individual stocks is the riskiest and most time-consuming way of gaining NASDAQ exposure, but some investors prefer it for the potential index-beating returns. Always conduct due diligence on your target stocks and ensure they align with your goals and timeframe.
Nasdaq-focused ETFs
If picking individual stocks isn’t ideal, consider an ETF - a basket of stocks based on a particular theme or strategy. One of the most popular ETFs is Invesco QQQ (NASDAQ: QQQ), the $260 billion cap-weighted colossus composed of the top 100 non-finance firms in the Composite. When choosing an ETF, consider the fund’s goals, methodology and costs before investing. Some QQQ alternatives include the broader Fidelity NASDAQ Composite ETF (NASDAQ: ONEQ) and the balanced Direxion NASDAQ-100 Equal Weighted Index (NASDAQ: QQQE).
Mutual Funds
Like ETFs, mutual funds are baskets of stocks bundled into a single security. However, ETFs trade on exchanges during open market hours; mutual funds aren’t actively traded, and shares can only be swapped after net asset value (NAV) is calculated at day’s end. Mutual funds are less tax-efficient than ETFs and frequently carry higher expense rates, but they’re the primary investment vehicle for 401(k) savers since ETFs aren’t allowed, and taxes on capital gains distributions can be deferred.
How to Choose the Right Investment Strategy
Picking an investment strategy requires a little self-analysis. What are your goals as an investor? How much risk do you want to take? You can’t control market returns, so focus on what’s within your grasp. Consider the following factors:
Time Horizon - How long do you plan on staying invested? If you have a long timeline, you can likely handle a riskier portfolio since you can dollar-cost average your way through a bear market. However, with short-term goals, a steep decline is tougher to tolerate.
Investment Goals - What’s the objective behind your investments? If you’re saving for retirement, consider tax-deferred accounts like a 401(k) or Roth IRA. But if you’re in a standard account, you won’t get tax advantages and will probably consider a different asset allocation.
Financial Situation - No one gives away stocks for free, and you need to consider how much you can afford to invest before buying any assets. If you max out your retirement vehicles and still have leftover income to invest, your plan might differ from someone who can only fill 80% of a 401(k) account. Investment decisions are always personal, so consult with an advisor if you want to get serious about building a portfolio.
A Guide for Getting Started
If you decide that exposure to NASDAQ stocks suits your investment goals, you must open a brokerage account to construct a portfolio. Don’t know where to get started? Follow these 4 simple steps:
1. Research and Select a Brokerage Firm
Now that commissions on stock and ETF investments are non-existent at most brokers, investors have more factors to consider when picking a broker. You’ll still need to research each broker’s fee schedule for transfer fees, inactivity fees and margin rates. But also consider features like charting tools, technical indicators, and research, especially if you’re actively trading individual stocks. If you’re choosing between a few favorites, look for a demo or paper trading account to test the platform before depositing any real cash.
2. Open a Trading Account
Once you’ve picked a broker, you must open an account. Your investment goals will dictate which account you open. Are you saving for retirement? Consider a traditional or Roth IRA for tax benefits. If you aren’t opening a tax-deferred account, you’ll need to choose between cash or margin. Margin accounts allow investors to borrow capital, but rates apply, and margin accounts are subject to pattern day trader (PDT) rules. Regardless of your account, you’ll need to fill out a few forms to register and provide documentation like a driver's license, social security or proof of residence.
3. Invest in Individual Stocks or Funds
If you have a portfolio strategy in mind for your NASDAQ investments, you can locate your preferred assets through your broker and purchase shares. If you don’t have a plan yet, use MarketBeat’s tools to narrow your stock selection and learn how to place orders.
4. Keep Up with Financial News
Even the best investment strategy requires occasional tweaking, so stay current with market headlines and economic news. If market sentiment changes, you may need to adjust your asset allocation sooner than initially anticipated.
Risks and Rewards of Investing in Nasdaq
Investing in NASDAQ, especially in securities like QQQ, has provided investors with breathtaking highs and stomach-churning lows. Look no further than the Dot Com Bubble to see how highly volatile tech stocks can run up past reasonable valuations, only to crash and burn devastatingly.
The NASDAQ Composite Index contains a wide range of stocks, including many small caps that lack favorable fundamentals. Additionally, the heaviest-weighted companies are tech giants like NVIDIA Corp (NASDAQ: NVDA) and Amazon Inc (NASDAQ: AMZN), which are known to be volatile despite their size and maturity.
Learning how to invest in NASDAQ requires a certain level of risk tolerance, but the gains over the last decade-plus have been worth it for investors. Thanks to large-cap tech, the NASDAQ 100 index has vastly outperformed the S&P 500 since the end of the Global Financial Crisis, although with deeper corrections and volatility along the way. Regardless of your investment strategy, always mitigate risk through diversification, have a long-term plan and be flexible if the market data changes.
Conclusion
The NASDAQ Composite is more volatile than its peers thanks to the tech concentration, but tech has been one of the most rewarding sectors in the post-GFC era. While a portfolio of only tech stocks might be too risky for the average investor, NASDAQ investments through ETFs can still allow for diverse portfolio construction.
Explore Your Options with MarketBeat
NASDAQ investing requires ample due diligence since the tech sector can be risky and volatile. If you want to enhance your stock research and analysis, consider the wealth of tools and reports MarketBeat offers. Click here to learn more about our offerings.
