This ETF Made Index Investing Cool Again -- And Made Shareholders Big Winners

Exchange-traded funds appeal to investors who like to keep things simple. Rather than doing research on countless individual stocks in the hope of finding enough promising prospects to create a well-diversified portfolio of 25 picks or more, the right ETF can give you instant diversification that's tailored to your particular investing strategy. And with thousands of different ETFs currently on the market, there's a fund that's likely to match up well with your wishes.

Yet as with everything in the financial world, the most successful ETFs have struck a chord with investors. As we discussed in our three-part series on the SPDR S&P 500 ETF Trust ETF (NYSEMKT: SPY) for the Voyager Portfolio, novelty is an important characteristic can draw investors' attention. But there's only so much room for ETFs that track the S&P 500. One ETF that proved that you could actually outperform the S&P 500 using an index investing approach was a game-changer for many investors. Here, you'll learn more about the Invesco QQQ Trust (NASDAQ: QQQ) and why it has become immensely popular.

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Overcoming the tech bust to become a massive hit

The strategy that the Invesco QQQ Trust follows is indeed quite simple. It aims to track the Nasdaq 100 Index, which is composed of the 100 largest companies by market capitalization that trade on the Nasdaq Stock Market and that aren't in the financial sector. The stocks in the Nasdaq 100 are weighted by market capitalization, so the largest stocks on the Nasdaq have more money allocated to them in the QQQ Trust than the smaller stocks do.

It would be hard to imagine a worse start to an exchange-traded fund than the one the Invesco QQQ Trust had to deal with. The ETF launched in 1999, when technology stocks were close to hitting their highs. Even today, the Nasdaq has a pronounced lean toward the tech sector, but at the time, that emphasis was even more profound. Most tech IPOs came public on the Nasdaq, not because they didn't qualify to be listed on the New York Stock Exchange but rather because they wanted the reputation that came from being Nasdaq-listed.

So when the tech bust led to the crushing bear market of 2000 to 2002, shares of the QQQ Trust were fully exposed. The drop eventually amounted to more than 80%, as even behemoths like Microsoft (NASDAQ: MSFT), Cisco Systems (NASDAQ: CSCO), and Intel (NASDAQ: INTC) weren't immune from the downturn.

Much worse, some companies that were near the top of the list among Nasdaq-listed companies simply fell out of the index entirely. WorldCom is perhaps the most infamous of these stocks, because of a massive multi-billion dollar accounting scandal involving fraudulent misclassifications of expenses and profits. But other big losers included Global Crossing, Metromedia Fiber Network, BroadVision, and At Home.

That kind of start might have doomed other ETFs, but Invesco QQQ persevered. Many of the larger companies in the Nasdaq 100 not only still exist today but have thrived. Many newer companies took the place of those that failed, and their performance has also been exemplary in some instances. Investors appreciated the durability of the ETF, and they also liked when the Invesco QQQ Trust started delivering returns that outpaced those of the S&P 500.

The simple reason why Invesco QQQ Trust has been a winner

In the end, Invesco QQQ Trust's outperformance is due to one simple fact: the Nasdaq 100 has done better than the S&P 500 for a long period of time now. As the lessons of 2000 to 2002 teach us, that isn't always destined to be the case. But nevertheless, investors have largely come to expect it, and Invesco QQQ has thrived from a fund perspective from a ton of attention and large fund inflows over time.

The next article in this series will look at just how successful the Invesco QQQ Trust has been. Here's a spoiler: recent returns have been truly mind-blowing for experienced investors who've seen far weaker periods for stocks.

Dan Caplinger has positions in Cisco Systems and Microsoft. The Motley Fool has positions in and recommends Cisco Systems, Intel, and Microsoft. The Motley Fool has a disclosure policy.