You will see in the Trader Wizard pages that I strongly recommend Exchange Traded Funds (ETF). ETFs are investment funds designed to track a market index and whose units are traded on an exchange pretty much like shares of listed companies. I even believe that most investors, including professional and sophisticated investors, could be very successful with an all-ETF portfolio.
Buying tracker funds is referred to as passive-aggressive investing. In fact, because of their passivity, and my belief in the need for independent investing, ETFs might look like something I’d never recommend. To the contrary, there should be a strategic role for them in your portfolio. You’ll see them in all my model portfolios.
There are now over a hundred ETFs globally, with almost US$200 billions in assets. ETFs have gained their popularity because they lend themselves to arbitraging, hedging and trading opportunities.
While they are still a long way from taking dominance over mutual funds (US$8 trillion) and hedge funds (US$1 trillion), for the simple reason they are not sold — and most of you are sold investments rather than buying them based on your own decisions — there will be a time ETFs will gain the upper hand.
Mark my words; they are simply that good.
ETFs represent a growing component of the securities industry, while mutual funds are on the decline. As more independent investors learn to avoid Wall Street while taking their self-managed portfolio transactions straight to the capital markets, this trend toward ETFs will further develop.
The large-cap ETFs you should consider as core holdings for your portfolio are listed on the American Stock Exchange (Amex), including:
(i) SPDRS, which track the S&P 500 index
(ii) QQQ, which track the Nasdaq 100 index
(iii) DIAMONDS, which track the Dow Jones Industrial Average.
It’s not all a bed of roses, however. With one or two of these passive funds, that is, one you never trade, you’ll get index returns at best, with no chance of out-performance; so timing your entry may be essential to your long-term success. Moreover, you will have to get involved in sector, industry and geographic investing.
I’m hoping that in the years ahead more institutions and individual investors will be convinced to take the “core-satellite approach” to actively managing their portfolio. This is where ETFs can best meet a need.
You should think of ETF investments as the portfolio core. It would contain the bulk of the investment in a way that’s broadly diversified, in leading companies on an indexed basis. That allows a much more targeted satellite focus on active managers to get them to do the task they are charged to do — to take aggressive buy/sell decisions on behalf of clients in much more focused way –- where the strategy is to build up long-term holdings in specific investments.
This may mean allocating as much as 50 to 75 per cent of equity funds into passive indexed vehicles, and the balance into actively managed stocks.
It is appropriate in my view for the professional and sophisticated investor to hold a 50% core position in ETFs. For the individual investor who is short of expertise, time and/or money for investment in securities, ETFs should play an even more significant role in your strategy. For such investors, I recommend as much as 75% of your equity exposure be in ETFs.
If you are in a younger age bracket, say your 20s and 30s, I’d recommend QQQ simply because they are more volatile, which in effect forces the investor to keep a closer watch on the up-and-down technology market, following the Intel’s, Oracle’s, Cisco’s, Dell’s and so forth. I’d also recommend a satellite holding in maybe two stocks that are constantly in the news: General Electric (NYSE: GE) and Intel (Nasdaq: INTC). In addition to being sound long-term investments, these two corporations can be particularly useful case studies for youthful students of the market.
If you are in the 40s and 50s mid-range of life, I’d recommend Diamonds (Amex: DIA) in combination with a broader list of quality stock components of the Dow Jones Industrial Average (DJIA) like GE, Home Depot, Intel, Microsoft and IBM because these are names that will come up frequently in your typical work day.
With an eye on retirement and during your retired years, I’d switch to SPDRS that track the S&P 500 along with some of the more stable, defensive components of the DJIA like McDonalds, Proctor and Gamble, Johnson and Johnson, Coca Cola and Wal-Mart.
In summary, the Exchange Traded Fund offers something to every investor. In the next part of this series, the Trader Wizard will dig deeper into fixed-income ETFs, and various types of sector, industry and geographically based ETFs.
For more information on ETFs, check out these four websites: (i) ETFCentral.com, (ii) Exchange-Traded-Funds.com, (iii) Morningstar.com, and (iv) IndexFunds.com.
As you know, the Trader Wizard has been focused in recent days on the Gold market. Interest overnight from Asian players has been quiet. The U.S. Dollar has gained against the Euro and Yen, keeping the bullion closely priced between $400-401. Because investors seem focused on tomorrow’s address to the Senate Banking Committee by Fed Chairman Alan Greenspan, in which he is likely to suggest whether interest rates will be increased or not, Gold should continue to base build between $395-405 for the time being. I am expecting a break-out to higher prices soon.
The Gold ETF I monitor is the S&P/TSX Capped Gold Fund (TSE_XGD).
By Bill Cara
Photo credit: MyTudut via VisualHunt / CC BY-NC-SA
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