Daily Gains Letter

Don’t Compromise Exposure; These Funds Key to a Diversified Portfolio

By for Daily Gains Letter | Apr 11, 2013


Stock advisors banter about asset allocation numbers all the time. Invest the percentage of your age in bonds and the rest in equities; unless you’re younger, then it’s wise to invest more in stocks. But then again, if you’re late to the investing table, maybe you’ll need to put more of your retirement portfolio in stocks to make up for lost time.

Asset allocation numbers can change depending on your age and your risk level. And since no two people are alike, no two asset allocation numbers are alike. It’s up to you and your risk level—and what you want your portfolio to accomplish.

Having said all that, more and more unhappy, cash-poor investors, tired of low interest rates, low returns, and high investment management fees, are turning their attention to the cost-effective and varied world of exchange-traded funds (ETFs).

ETFs are investments that mirror (or at least attempt to mirror) the return of a particular index. ETFs allow average investors the chance to add a basket of equities to their retirement portfolio that they could not otherwise afford to purchase individually.

Whatever you want to invest in, there’s an ETF for it. Currently, there are approximately 1,200 ETFs available in the U.S. The more obvious ETFs follow the Dow Jones Industrial Average, the S&P 500, Russell 3000, and the Toronto Stock Exchange (TSX). Then there are currency ETFs that track the Swiss franc, Japanese yen, or the euro. Commodity ETFs track oil, natural gas, gold, livestock, grain, and precious metals. There are even religious-based ETFs.

Many investors choose to buy ETFs in an effort to diversify their holdings, reduce volatility, and keep costs down. With so many different ETFs to choose from, some investors have tossed asset allocation out the window and are 100% invested in ETFs. While only three percent of U.S. households own at least one ETF, that number is expected to grow due to ease of use.

ETFs may be an attractive investment option, but like any investment vehicle, it’s important to understand what you’re investing in. Some ETFs are pretty straightforward. The ProShares Ultra S&P500 (NYSEArca/SSO) corresponds to two-times the daily performance of the S&P 500. If the S&P 500 goes up five percent in one day, this ETF goes up 10%. If the S&P 500 retraces by three percent, this ETF will trade down six percent.

On the other hand, the Madison/Claymore Covered Call & Equity Strategy Fund (NYSE/MCN) is based on more complex investment management strategies. This ETF sells call options on the equities in the fund.

With so many choices, how do investors build a portfolio using ETFs? Again, only invest in what you understand. If you’re just starting out, it might be a good idea to consider a broad-based ETF that is low-cost and liquid and is made up of a well-diversified number of stocks.

The smallest ETF is the SPDR Dow Jones Industrial Average (NYSEArca/DIA), with 30 industrial stocks; the largest ETF is the iShares Russell 3000 Index (NYSEArca/IWV), with $4.1 billion under management.

Those who want to follow a traditional asset allocation regimen can continue to do so with ETFs. Simply invest a certain percentage of your portfolio in bond-related ETFs and put the rest in equity-based ETFs.

The Vanguard Long-Term Govt Bd Idx ETF (NASDAQ/VGLT) provides investors with broad exposure to U.S. investment-grade bonds with maturities of more than 10 years. About 60% of this ETF’s assets are in corporate bonds and 40% are in U.S. government bonds.

So it’s true that less is more. With ETFs, even investors with small retirement funds can have a diversified portfolio without compromising exposure.

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