Over the years, more and more investors have come to embrace the exchange-traded fund structure. For the most part, many have chosen ETFs over mutual funds because of the significantly lower expense, as well as the ability to trade these securities throughout the day [see Understanding the Mutual Fund vs. ETF Cost Difference].
Though cost and ease-of-use are two important factors, investors do not always realize the biggest benefit of ETFs – diversification. Exchange-traded funds allow investors to tap into nearly every corner of the investable universe, while at the same time mitigating the risks associated with holding a single stock. To visualize this risk, let’s put single stock volatility into perspective:
|Company||52 Week Range||Absolute % Difference of Range|
|Twitter (TWTR)||29.51 – 74.73||153%|
|Whole Foods Market (WFM)||37.02 – 65.59||77%|
|Apple (AAPL)||55.55 – 95.05||71%|
|Staples (SPLS)||10.86 – 17.30||59%|
|Family Dollar Stores (FDO)||55.64 – 75.29||35%|
Above is a table featuring five companies’ 52-week ranges. The second column is the absolute percent difference between the 52-week high and the 52-week low (Note that all data is as of 6/10/2014). All five of these companies have significantly wide 52-week ranges, which should be a red flag for buy-and-hold investors.
Swings Can Go Both Ways
While markets generally do not move drastically, single securities have been known to exhibit significantly volatile price movements, especially in recent years.
In the case of Twitter (TWTR), which IPOed in November of 2013, the stock rose 63% from its first day of trading to its peak price of over $73. Just two days after reaching its peak, the stock tumbled 17.46%:
If, however, you bought Twitter stock on its first day of trading and held it until today, you would be down over 20% on your investment.
Since IPOs are notoriously volatile, let’s look at a more established company. Apple (AAPL) has also been subject to big price swings over the trailing one-year period, but that swing goes in favor for investors who were lucky enough to buy on the dip. By June of 2013, Apple shares had fallen to about $55 per share, well off its all time high of more than $100. If you were to have bought the stock on the dip, you would be up over 66% on your investment [see 10 of the Best ETF Trades of All Time]:
Family Dollar (FDO) is another great example of single stock volatility. In 2013, the stock traded in a relatively narrow range, gaining under 1.5% on the year. By the end of May of this year, FDO fell more than 11% after the company reported lackluster earnings and disappointing forward guidance. But after notorious investor Carl Icahn announced his 9% stake in the company, the stock rallied over 13% in a single session.
Whole Foods Market
In 2013, Whole Foods Market (WFM) logged in a solid 25% gain on the year. For the first four months of 2014, WFM traded in a rather narrow range, but after the company reported disappointing Q1 earnings and slashed guidance, the stock plummeted over 18%:
Over the trailing one-year period, Staples (SPLS) has taken several steep hits. Its most recent drop occurred at the end of May 2014, when the company posted worse-than-expected earnings results and lackluster guidance. Subsequently, Staples’ shares fell 10% after the earnings announcement. The stock took a similar beating after the company reported sour Q4 2013 earnings.
The Bottom Line
While there are certainly some funds that do exhibit relatively high levels of volatility, most equity ETFs offer enough diversification benefits to buffer swings of individual holdings. Though stock swings can certainly work in an investor’s favor, in the long-run, investing in a well-diversified ETF will mitigate the sometimes costly risk associated with single stock volatility.
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Disclosure: No positions at time of writing.