Getting in on the ground floor of a successful new public company can provide you with huge returns. That’s why initial public offerings ( IPOs ) so often capture our imagination and the media’s attention.
IPO investing can be risky, however. That’s why it’s worth checking out exchange-traded funds that invest in IPOs—so-called IPO ETFs. They can give you access to the shares of hundreds of newly public companies, delivering higher returns plus diversification to minimize your risk. What Is an IPO ETF?
An IPO ETF is an exchange-traded fund that tracks the performance of companies that have recently gone public. By buying shares of an IPO ETF, you’re able to invest in a large number of IPOs with a single fund.
“IPO ETFs would allow an investor to share in the IPO market without having to be a stock-picking expert, with the risk that entails,” says Ronnie Colvin, a certified financial planner ( CFP ) with French Press Financial Services. That’s important because individual IPO stocks can be incredibly risky.
Why are IPOs so risky? For starters, IPO shares frequently aren’t available to average consumers at their lowest, most attractive prices. By the time you’re able to snag shares of new companies, they may already have experienced temporary price spikes, and you may struggle to match, much less exceed, the inflated price you bought in at long term.
What’s more, newly public companies lack the track record of more established names, meaning they may experience more turbulence and pose a greater likelihood of investors losing their money. In fact, after five years, more than 60% of IPO companies’ stocks have lost value, according to a UBS analysis of University of Florida IPO data from 1975 to 2011. IPO ETF Advantages
Invest in Multiple IPO Companies
When you buy shares of a new IPO, your investment is entirely dependent on one company’s performance. If its stock price tanks, you could lose a substantial part of your investment. This is true of any single-stock investment, of course, but the risk is particularly acute with companies that are new to the vagaries of public stock markets.
By contrast, when you purchase the shares of an IPO ETF, you’re investing in dozens or even hundreds of IPOs at once, diversifying your holdings. If one company owned by the fund does poorly, the performance of the other IPO companies should offset it, helping to minimize any losses from a bad IPO. Own Companies that Aren’t Included in Traditional Indexes
Buying index funds and ETFs is a staple of successful long-term investing as it offers low costs but market-matching returns. Unfortunately, many index funds, especially those modeled on large-cap indexes like the S&P 500 , omit smaller companies and new IPOs.
These smaller, newer companies can be riskier investments because their stocks may not trade as frequently as larger companies’, meaning they have less liquidity . Smaller companies may also experience more extreme ups and downs in the market, as they lack the diversification and financial reserves of larger companies to weather negative events.
With that greater risk, however, comes greater potential rewards. Small and new companies have more room for exponential growth, which can help you supercharge your investing dollars more than you can with large companies with slow (but steady) growth trajectories.
Think about if you had invested in Tesla ( TSLA ) right when it IPOed, for example. In the first 10 years of TSLA’s public life, it grew more than 4,000%. During that same period, the S&P 500, which didn’t include Tesla at the time, gained a comparatively palty 187%.
This shows the value of an IPO ETF. This kind of fund lets you in on early-stage companies poised for stratospheric growth that aren’t big or established enough to be included in major market indexes . By the time Tesla was large enough to be included in the S&P 500, it had already experienced many thousands of percent growth that normal index investors missed out on. IPO ETF Disadvantages
Returns May Be Lower than Buying Individual IPOs
Investing in IPO ETFs can reduce your risk, but it will also dilute your potential returns. If one company in the ETF skyrockets, you’ll have a lower return on investment since your money is spread across many companies, some of which may drag down your total return.
“In the ETF, investors would benefit if the chosen stocks rise, but not nearly as much as if they had bought the stocks themselves directly,” Colvin notes.
That doesn’t mean you won’t still see attractive returns. Since […]
source IPO ETF: Invest In Initial Public Offerings With Funds
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