Boot up Your Returns With Tech Stocks?

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Published May 17, 2011

| Bankrate.com

Tech stocks are hot, thanks to innovations like smartphones, computer tablets and social media. But while experts are enthused about tech's future, they add that the sector's known for stomach-churning volatility and the occasional high-flying casualty. Here's what to look for, and what to watch out for.

Why it's Interesting

For starters, think about how technology rules our lives. Less than a lifetime ago, computers were something used by corporations and the industry was so dominated by one company -- International Business Machines -- that the federal government deemed it a monopoly and filed an antitrust suit (later dropped) that could have broken up the company. That was the era when kids played games that frequently involved moving tokens and rolling dice. Music was distributed on vinyl discs called records, which were sold by businesses called record stores. Students did research by going to libraries and looking through a multidrawer monstrosity called a card catalogue.

Small wonder this is probably the most exciting industry in the world right now. It's why Bill Gates is a household name, why Steve Jobs is a cultural icon and why the lives of a group of Harvard geeks became a hit movie called "The Social Network." Tech is constantly reinventing the world we live in, doing everything from turning our coffeepot on automatically to letting us call our overseas friends for free.

Tech so permeates our world that it can be difficult to categorize as a sector. It includes search engines such as Google, social media such as Facebook, software writers such as Microsoft and hardware manufacturers such as Hewlett-Packard. Online retailers such as eBay and Amazon generally are considered tech firms, as are broadband providers like Qualcomm. "It's a big definition," says Michael Masiello, a Rochester, N.Y., financial adviser and president of Masiello & Associates. "As a realistic person, you need technology in your portfolio. The question is, how much and what types?"

Why Investors Should Care

We live in a digital world, and that has produced multidigit gains for untold numbers of investors. Tech stocks were also one of the better ways to weather the recent economic storms. Tech funds had the second-best performance of domestic stock funds tracked by Morningstar during the past three years. Only health funds did better. Admittedly, the competition wasn't much during the Great Recession; overall, tech funds are up just under 8% in the last three years. (In the last year, however, they gained 27.84%.)

But beware, this is not a game where everyone wins. For every Apple that blossoms there's a Flip that flops. Cisco recently said it's shuttering its once wildly popular digital camera line whose technology was overtaken by smartphones.

Mergers and acquisitions are another reason for investors to care, since deals can often produce sharp price changes -- though not always for the better. Microsoft recently saw a window of opportunity and plunked down $8.5 billion for Skype, the Internet phone service. Earlier, AT&T rang in with a $39 billion bid to buy T-Mobile USA from Deutsche Telekom.

How You Get Into the Market

Mutual funds are one of the easiest ways to invest in technology. There are 55 different technology sector mutual funds, according to Morningstar. Mutual fund organizations like Vanguard, Fidelity or T. Rowe Price typically have a tech fund. Or you can buy in via a broker

And of course, there are plenty of individual shares to select from. And some of the returns are eye-popping. No doubt Apple investors are pealing with delight over its five-year return exceeding 400%. And Google's five-year gain of 43% is the kind of respectable number investors often search for.

Just be aware that in an industry this competitive, even giants are vulnerable. Your five-year return on Microsoft would be around 11%. And one-time PC leader Dell is down more than 30% over the past five years.

Masiello advises clients that tech might comprise in the 20% to 30% range of a portfolio. But he prefers funds over betting on the next big thing. "If it's something they have a compelling reason for owning, I might say, 'Sure, here's some hobby money. Go have fun.' But if not, don't own Google just because everybody owns Google."

If you're willing, wealthy and well-connected, there's a highly exclusive way to get into the tech market: through a private placement of a hot company before it goes public. Goldman Sachs did that earlier this year with a $500 million stake it bought in Facebook. However, only its non-U.S. customers were allowed to buy.

Risks

The hub of the tech world is Silicon Valley. But considering how tech shares perform, it might be better called Silicon Peaks and Valleys.

Remember when the dot-com bubble burst? The tech-heavy Nasdaq Composite index reached an all-time high of 5,048 in early 2000. More than a decade later, it's less than 3,000 today.

Courtney Dobrow, a mutual fund analyst with Morningstar, says investing in tech is not for the squeamish. "It's a category that can gain 62% in one year and lose 45% the next," she says. "So you have to be willing to weather the ups and downs. The sector really is prone to boom-and-bust cycles, so you have to be prepared if you decide to invest in one of these funds."

Outlook

The years ahead promise rapid development in new technologies, meaning risks and rewards for investors. Whether it's smartphones, apps, tablets, cloud computing or e-retailing, tech firms are wired for the future -- which actually is increasingly looking to be wireless. "What's not a technology company?" Masiello asks rhetorically.

Liquidity

Mutual funds are highly liquid, as are the shares of the big publicly owned companies in this sector. Most fund companies allow you to exchange shares of one fund for another fund. If you wanted to buy shares in a technology fund, for example, you could exchange shares in another fund you own at that company for shares in a technology fund.

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