Tracking the Nasdaq

The Nasdaq index is capturing everyone's interest, but there are precious few ways to invest in it. The performance of the Nasdaq has gone through the roof in the past few years. Created in 1971, it didn't reach 1000 until July 7, 1995; it took less than five to get from 1000 to 5000.

There are actually two separate Nasdaq indices: the composite Nasdaq (the one you always hear about on the news) and the Nasdaq-100. The composite Nasdaq tracks 4,818 stocks each day. The Nasdaq-100 tracks the top 100 Nasdaq stocks, including some heavy-hitting tech stocks like Microsoft, Qualcomm and Cisco Systems.

The composite Nasdaq is difficult to track by an index fund because of its size. Nearly 5,000 stocks would have to be managed in straight-forward index fund that tracks the composite Nasdaq 100%. The Nasdaq-100, however, is ideal for an index fund.

The first fund to track the Nasdaq-100 was the Rydex OTC (RYOCX), which launched in 1994. Unfortunately the fees and minimum investment are high for an index fund.

The Potomac OTC Plus (POTXC) and Profunds Ultra OTC (UOPIX) also track the Nasdaq, but they aren't straightforward indexes. They use leverage (for example, from futures) to surpass the index rather than simply match it. This means that an increase in the Nasdaq results in an exaggerated increase in the fund; the downside is that a Nasdaq drop results in exaggerated losses for the fund.

An alternative to these is QQQ, a year-old ETF (exchange-traded fund) put out by the Nasdaq-Amex Market Group, available from any broker.  By purchasing a share of QQQ, you invest in the Nasdaq-100 Trust, a unit investment trust that holds shares of the companies in the Nasdaq-100 Index. This fund has relatively modest fees of 0.18%. Since it functions like a stock, you must pay brokerage fees to buy and sell; for buy-and-holders, the low fees make it worth investigating.

A recent addition to the field is an offering from  California Investment Trust .  This fund charges a moderate expense ratio of 0.65% and has an initial investment of $5,000.  There is no minimum for IRA investments.  Note, however, that the fund is capping expenses at 0.65% for the first year so they may go up in the future.

The following table illustrates the differences between these funds:
 

The Nasdaq has been leaping up and up for the past three years, which is usually a warning sign that a correction is due. Should you avoid the Nasdaq because it's volatile? Not necessarily. For index fund investors, the opportunity to own a large share of the market is the goal. Indexing is about long-term investment, and the realization that there may be some bumps in the road. The low fees of index funds mean that riding out a rough spot is feasible.
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