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SPY, an Exchange Traded Fund, or ETF (further defined below), tracks a market-cap-weighted index of US large- and midcap stocks selected by the S&P Committee.From ETF.com:
SPY is the best-recognized, oldest and largest ETF—and the most liquid security in the world. The fund tracks the most popular US index, the S&P 500. Few realize that S&P's index committee picks and chooses 500 securities to represent the US large-cap space—not necessarily the 500 largest in order of market cap. The outcome: SPY doesn't hold American Airlines or Twitter, but does hold midcaps for 9% of the portfolio. The fund has one of the lowest expense ratios in the segment, but costs more to hold than its main competitors, IVV and VOO. SPY's monster volumes make it the perfect vehicle for gaining quick exposure to the US large-cap space.
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SPY is the most liquid ETF in the world. Over 100M shares change hands on most days, equivalent to over $20B. SPY trades at 1 cent spreads all day long. It boasts the most active options market for any ETF. The fund is easy for market makers to hedge, so large trades sail through. Investors of all stripes should have no trouble trading SPY at fair value.
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SPY is the largest ETF on the market by AUM. As a UIT, SPY may not optimize its portfolio, lend securities or reinvest its dividends. Therefore, it holds the stock of all 500 index firms, earns no securities-lending income and experiences some dividend drag. This most likely explains why it lags the S&P 500 by a median 17 bps, despite charging 9 bps.
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SPY delivers solid coverage of US large-cap stocks. Despite extending into the midcaps, the fund has only minor sector deviations from our benchmark. The midcap exposure adds slightly to its market risk (beta of 1.01) and introduces a mild size tilt to the portfolio. Overall, it's a very good, if slightly skewed, representation of the US large-cap space.They also have a bunch of cool infographics about the make-up, performance and other good-to-know details here: http://www.etf.com/SPY
Surface view sounds pretty good, right? Some of the analysis techniques that are valuable for individual stocks are not viable here because SPY tracks on 500 tickets.
Why does it, or doesn't it, fit in my portfolio?
There are a number of reasons why SPY is effective at accomplishing what I want in my portfolio.- Diversification
- Low expense ratios
Downsides:
- Captures the entire S&P 500. There is no Alpha (see definition below). The SPY ETF follows (or more accurately, slightly lags behind) the market as a whole. SPY will never outperform the market because it is the market.
If it does fit, how much of my portfolio do I want to consist of this particular fund?
In regards to initial investment, SPY looks like a great first move. This can obviously be expanded.
Definitions:
ETF
...from Investopedia:
An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.
Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated once at the end of every day like a mutual fund does.
Alpha
...from Investopedia:
1. A measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha.
2. The abnormal rate of return on a security or portfolio in excess of what would be predicted by an equilibrium model like the capital asset pricing model (CAPM).
Alpha is one of five technical risk ratios; the others are beta, standard deviation, R-squared, and the Sharpe ratio. These are all statistical measurements used in modern portfolio theory (MPT). All of these indicators are intended to help investors determine the risk-reward profile of a mutual fund. Simply stated, alpha is often considered to represent the value that a portfolio manager adds to or subtracts from a fund's return.
A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha would indicate an underperformance of 1%.
