As the market prepares for the highly anticipated Twitter initial public offering (IPO), many investors will be tempted to jump in by the promise of big gains.
As we've warned you, investing in IPOs can be a very high-risk enterprise.
Winners can double or triple your money in very short order. But losers can cut your investment in half, or worse, just as quickly. Anyone who was around for the dot-com bubble of the late 1990s probably still has nightmares about the disastrous IPOs from that era.
And then there's the great difficulty that retail investors have in buying IPOs at anything close to the offer price. Anyone who tries often finds that they buy only after the IPO stock has soared, locking them out of most of the first day's gains.
But there is a way to capture the big gains in the IPO market with less risk than buying an individual newly issued stock: investing in IPO ETFs.
The fact is, despite all the headaches, IPOs often provide very hefty gains…
Just take a look at the performance this year of the Renaissance IPO index. It's up 56.6%, compared to a good but more modest 22.4% gain for the Standard & Poor's 500 index.
Its performance is tracked by the Renaissance IPO ETF (NYSE ARCA: IPO), which started trading on Oct. 16.
The First Trust U.S. IPO Index (NYSE ARCA: FPX), which launched in 2006, has also done well this year, having risen 37.48%.
True, those numbers aren't as eye-popping as what you'll see from the best IPOs. Every one of the top 10 best IPOs of 2013, for example, are up at least 140% – and several are up more than 200%.
On the other hand, no one wants to be stuck with an IPO dog.
Professional Diversity Network Inc. (Nasdaq: IPDN), for example, is down 39% from its March 8 offer price. And Groupon Inc. (Nasdaq: GRPN) is down 62% from its first-day close of $26.11 back on Nov. 4, 2011.
Unless you're really good at picking IPO winners, you'll want to seriously consider investing in an IPO exchange-traded fund (ETF).
Let's take a closer look at these two IPO ETFs, because they use slightly different approaches.
Investing in IPO ETFs: Two Distinct Choices
First of all, neither IPO ETF buys in at the offer price, as most people would suspect.