Investor Independence via ETFs — Part 5

invest offshore in diamondsThere are probably twenty good reasons for chucking your mutual funds and replacing them with Exchange Traded Funds (ETFs). Let me give you three: ETFs perform better, manage risk better and cost less.

If you are an active trader, let me give you another: you trade them exactly like you do stocks.

So overwhelming are the comparative benefits, it’s only a matter of time before the small ETF industry (US$150 billion) grows to the size of the $8 trillion mutual fund industry.

Yesterday, we delved into the major equity market tracking funds – the Spiders, Diamonds and Qubes. Spiders of course are the SPDRS that track the S&P 500 Index. The Diamonds stand for the DIA fund that tracks the Dow Jones Industrial Average. Qubes are the QQQ, which is the Nasdaq-100 Index tracking stock.

While there are 120 other ETFs you can trade, these three represent half the $150+ billion invested in these funds. The ETF industry is just 10 years old (late 1993), so as independent investors become more aware, rest assured the popularity of the ETF will grow quickly.

Already the Exchange Traded Fund market is rapidly developing new products. In addition to Spiders, Diamonds and Qubes, there are now iShares, Select Sector SPDRs, streetTRACKS, VIPERs, RYDEX and POWERSHARES. The good thing is that just like there are Granny Smith, McIntosh, Delicious (Red or Golden), Royal Gala, Fuji and many other varieties of apple, you know an ETF is an ETF like an apple is an apple. Like you’ll choose one apple over another based on your desire to eat, cook or drink the product, you will select an ETF to meet your portfolio needs.

Today, we will describe the types of tracking coverage available with ETFs that are not large cap trackers. Yes, with ETFs, you can get mid-cap and small-cap coverage too.

Depending on your age and risk profile, I believe that the small-cap and mid-cap blue-chip equity ETFs should also be a core investment for any all-ETF portfolio, occupying up to 40 percent, depending on your portfolio’s ideal asset allocations.

For mid-caps, there’s the S&P 400 Mid-Cap Spider (AMEX: MDY) or the iShares S&P Mid-cap 400 (AMEX: IJH).

For small-caps, consider Barclays iShares Russell 2000 (AMEX: IWM) or iShares S&P SmallCap 600 (AMEX: IJR). There is also a fairly new product called the PowerShares Dynamic OTC Portfolio (AMEX:PWO), which “seeks investment results that, before expenses, generally correspond to the price and yield performance of the Dynamic OTC Intellidex Index, which is comprised of 100 over-the-counter market securities, selected each quarter by the AMEX. The OTC Intellidex uses OTC market- like sector weightings and market-cap groupings as represented by the NASDAQ market in seeking to produce a sector and size dispersion similar to the overall broad OTC market”. This is an interesting ETF, which I encourage readers to look into.

As at December 31, 2003, PWO held some interesting stocks, including: Synopsys (Nasdaq:SNPS) (3.8%), Foundry Networks (Nasdaq:FDRY) (3.6%), Cisco (Nasdaq:CSCO) (3.5%), Sanmina-Sci Corp (Nasdaq:SANM) (3.5%), Autodesk (Nasdaq:ADSK) (3.4%), and Adtran (Nasdaq:ADTN) (3.2%). In addition to coverage of Technology (56%), there is also Consumer Discretionary (12.8%), Healthcare (11.8%), Financials (10.0%) and Industrials (5.0%). Since inception one year ago, this ETF is up 42.0% and has a Total Expense Ratio of just 0.60%. While I am not recommending PWO here, I do wonder if your mutual fund portfolio has performed better, given you greater diversification or cost less. I think we both know the answer.

Tomorrow, I’ll get into a discussion of the various investment styles that select ETFs have been designed for. Yes, there are even ETFs for value, blended or growth-oriented investors. Later, I’ll cover the ETFs designed to track all manner of international investments.

By the end of this series, I hope to make a difference in the knowledge and outlook for the average investor, right up to and including sophisticated and professional investors.

If, as and when some of you choose for the first time to invest in Exchange Traded Funds, the Trader Wizard will be a happy writer.

By Bill Cara

BillCara@TraderWizard.com

Source: Trader Wizard


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