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3 Top Technology ETFs to Buy in 2016

By Keith Noonan – Oct 15, 2016 at 8:02PM

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These technology ETFs offer tradability, competitive expenses, and ways to ride momentum in the sector.

Image source: Getty Images.

A technology ETF, short for exchange-traded fund, is essentially an index fund that links a group of tech equities together as a single security trading on the market. These securities trade like stocks and give investors an opportunity to ride momentum in the broader technology industry or a specific segment of it while diversifying their holdings to minimize risk. ETFs often carry lower fees than investing directly in stocks to mirror an index, and do not have the minimum investment thresholds required by many mutual funds, making them relatively easy and versatile ways to take broad positions in technology. 

With the tech sector generally more prone to big volatility than other segments of the market, investing in technology ETFs can be a good way to stake a long-term position that requires little in the way of investor management and perhaps provides some downside protection by being spread across multiple stocks. Investors looking to minimize risk and expenses should look to market-weighted ETFs, funds which determine weightings based on the market value of securities and are assembled to track an index rather than aiming to outperform it. With that in mind, here are three top market-weighted technology ETFs to buy in 2016.

Vanguard Information Technology ETF

The Vanguard Information Technology ETF (VGT 0.18%) offers investors exposure to a wide range of the tech sector at a low cost and with very high liquidity, and aims to track the MSCI US Investable Market Information Technology 25/50 Index. The fund says its expense ratio is 93% lower than the average expense ratio of funds with similar holdings. It sits at just 0.1%, representing an annual cost of $1 for every $1,000 invested.

VGT tracks 374 stocks, manages roughly $9.9 billion in assets, and has a daily average trading volume of over 391,000 shares over the last three months, providing ease of securing or exiting a position. Its main holdings are spread out over software and IT services (47.3%), device hardware (16.4%), semiconductors (13%), professional and communications services (11%), and networking (7%), and the top five equities in the fund are Apple at roughly 12.5% of net holdings, Alphabet at 10%, Microsoft at 9.2%, Facebook at 6.2%, and Intel at 3.6%.

The VGT does not include telecom stocks, but does include stakes in credit card companies with Visa (roughly 3.3% of net holdings) and MasterCard (roughly 2% of net holdings) representing the seventh and 10th biggest stakes, respectively. The fund's 10 largest holdings account for roughly 56% of net assets. While the VGT is largely comprised of big S&P 500 tech holdings, it also holds substantial stakes in small- and mid-cap stocks.

VGT is up roughly 12% year-to-date, and has a dividend yield of roughly 1.3%. 

Technology Select Sector SPDR ETF

Like the Vanguard Information Technology ETF, the Technology Select Sector SPDR ETF (XLK 0.26%) offers broad exposure to the tech sector with high liquidity and relatively low expense fees. XLK aims to track the Technology Select Sector Index, and is the largest of the tech ETFs by measure of total assets, with roughly $13.1 billion in assets under management held across 72 securities. The fund is also the most traded tech ETF, with an average of more than 1 million shares traded daily over the last three months. While XLK is traded substantially more than VGT, both funds are highly liquid to the point that composition of holdings and expenses are the more important differentiating factors.   Its annual expense ratio sits at 0.14% -- 40% higher than VGT's but still low relative to most other comparable tech ETFs.

XLK is more top-heavy than VGT, with its top 10 holdings making up 63.6% of the fund. Unlike VGT, XLK holds no small-cap companies and is light on mid-caps, making it less exposed to the volatility associated with non-large-cap companies.

The top five equities in the fund are Apple at 13.8% of holdings, Alphabet at 10.4%, Microsoft at 10.1%, Facebook at 6.7%, and AT&T at 5.4%.  In terms of composition of assets, one of the main differences between XLK and VGT is that XLK has significant telecom holdings. The fund's seventh-largest holding is Verizon -- at roughly 3.8% of the total fund. Investors looking for exposure to telecom companies might choose to go with XLK over VGT for that reason.

Looking at VGT's top holdings by sector, software and IT services represent 41.8% of net holdings, computing hardware 16.6%, semiconductors 11.3%, telecommunications 10.4%, and professional and communications services 10.2%.

The fund is up roughly 13% year-to-date, and has a dividend yield of approximately 1.7%.

First Trust Dow Jones Internet ETF

Investors willing to tolerate greater risk in pursuit of greater returns and of the mind that internet companies stand a strong chance of leading the tech sector in coming years should consider the First Trust Dow Jones Internet ETF (FDN 0.01%), which is built to track the Dow Jones Internet Composite Index. Unlike VGT, XLK, and other broad-coverage ETFs, FDN is not diversified outside of internet-related businesses -- a characteristic that exposes it to greater volatility, but also opens the door for large gains if internet sector momentum continues. First Trust lists stocks under the information technology segment as making up 70.3% of holdings, with consumer discretionary the next largest segment at 21.4%, followed by financials at 4.7%, healthcare at 2.7%, and telecommunication services at 1%. 

FDN is the largest of the dedicated internet ETFs by measure of total assets, covering 42 securities, and with net holdings of roughly $3.7 billion. The fund's expense ratio of 0.54% is in line with comparable internet-focused funds, but FDN offers the advantage of strong liquidity -- with average daily trading volume of roughly 510,000 shares over the last three months. The company's top five largest holdings are at 10.6%, Alphabet at 9.8%, Facebook at 9.7%, Netflix at 4.8%, and PayPal at 4.7%. 

For the internet-focused ETF investor, FDN's reasonable costs and tradability make it a top choice. The fund is up 9.4% year-to-date; it does not pay a dividend. 

Keith Noonan has no position in any stocks mentioned. The Motley Fool owns shares of and recommends AAPL, FB, MA, NFLX, PYPL, and V. The Motley Fool owns shares of MSFT and has the following options: long January 2018 $90 calls on AAPL and short January 2018 $95 calls on AAPL. The Motley Fool recommends INTC and VZ. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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