High risk, high reward.
That's what experts say investors would be signing themselves up for if they add biotechnology ETFs to their portfolios right now.
"You're investing in a cutting-edge technology that has substantial potential for gains as new drug therapies develop," said Ric Edelman, founder of Edelman Financial Services. "The con is they pose equally huge risks since most technology is unproven. [Biotech] is also very expensive and time consuming."
The industry is also very competitive and many companies' success hinges on the performance of one or two drugs, which might deter some investors who want a safer approach to their investment portfolio. This boom-or-bust mentality though can excite investors, but it's important for these people to know what kind of ETF they should seek out.
- Jim Cramer's Investing Rule 25: There's Always a Bull Market
- Jim Cramer's Investing Rule 24: Explain Your Picks
Biotech ETFs offer a variety of options to choose from depending on what an investor desires. Within the biotech sector, there are ETFs that hold just small and mid-cap companies or that involve an even more specific subsection of the industry. However, average investors might want to look at the two largest biotech ETFs — the iShares Nasdaq Biotechnology ETF (IBB) - Get Report and SPDR S&P Biotech ETF (XBI) - Get Report — for more promising returns on their investments, George Gagliardi, a financial advisor for Coromandel Wealth Management, said in an email to TheStreet.
"XBI is equal weighted, rebalanced periodically, and allows the buyer to place similar wagers on over 100 different biotech companies," Gagliardi said. "IBB consists of nearly 200 cap-weighted biotech stocks, and the buyer gets larger positions in the larger and more well-known biotechs."
Since the beginning of the year, the IBB has underperfomed against the Nasdaq Composite I:IXIC , gaining 1% compared to the Nasdaq's 7%. Conversely, the XBI has outperformed the S&P 500 by 10%.
Edelman advises people looking to invest in biotech ETFs to devote no more than 2-4% of their portfolio to the industry because of the volatility associated with the underlying companies. If people want to take an even more conservative approach to investing in biotech, they can look at diversifying their portfolio to include exponential technologies ETFs.
These ETFs cover a broader range of technology to include different sectors like biotech, artificial intelligence and robotics. Edelman is bullish on exponential technologies and suggests people allocate anywhere from 5-25% of their portfolio to these ETFs. Putting a quarter of an investor's portfolio might buck the the advice of most planners who preach diversification as the best route to follow, but Edelman says emerging technologies are worth the risk.
"It's an appropriate overweighting considering the rapid pace of development in technology and the dominate role it will play in the economy for decades to come," Edelman said.
Investing in biotechnology could lead to a substantial payday, but people should understand all of the risks associated with an ETF and know that a few companies can influence how the whole industry does, Matthew Gaffey, a wealth manager at Corbett Road Wealth Management, said in an email.
So buyer beware.