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Eight Rules For ETF Success
Managing a global portfolio of exchange-traded funds (ETFs) is a
great way to build a diversified portfolio with exposure to
equities around the globe. Fortunately, you need not be a rocket
scientist to do this, but many investors fail to observe some
basic guidelines, and it can get them into real trouble. Follow
these eight steps and sleep easier.
1. Liquidity Comes First: Before you even think of building an
investment portfolio, you should set aside about six months of
income in a "rainy day" account. This could be put into a money
market fund or U.S. Treasury securities. Having this money set
aside will ease your mind and allow you to be more open and
creative with your global portfolios.
2. Separate Portfolios: You should separate your core
conservative portfolio from your growth portfolios. With the
core conservative portfolio, your top priority is capital
preservation, and growth is a secondary consideration. Your
growth portfolios are more speculative, with capital growth as
the primary goal.
3. Really Diversify Your Portfolios: You need positions in your
portfolios that are likely to offset each other as unexpected
events and market movements become a reality. This is not
accomplished with different sectors of ETFs or a mix of
small-cap, mid-cap and large-cap ETFs. Rather the goal is to
have some investments that are on both sides of risks.
For example, if the U.S. dollar declines, have some investments
in precious metals or denominated in other currencies, such as
Switzerland or Australia or Singapore ETFs. If inflation heats
up, have some investments that hedge this risk such as timber,
gold or Treasury inflation-protected bonds (TIPs). If political
events or policies in one country take a turn for the worst, it
is helpful to have investments in other well-developed countries
to offset any loss of value. You get the idea, spread your risk
and avoid having one ETF account for more than 5%-10% of your
core portfolio.
4. Be Careful Which Countries You Pick: You need some guidelines
to help keep you from getting carried away and having too
concentrated a position in a particular country or region. In
particular, take a good look at the following: 1) the stability
and overall political and corporate governance; 2) the legal
environment, respect for contracts, low levels of corruption,
due process and rule of law; 3) the macroeconomic environment
including fiscal discipline and currency strength; and 4)
political risks that could affect financial markets.
Keep in mind that the quality of the countries you choose to
invest in is the primary but not the only factor. The price or
valuation of a country's stock market is also extremely
important. Oftentimes, the best time to buy into a country's
stock market is when it is beaten down, but there are signs that
its economic and political problems will sharply improve. If you
have a long-term perspective, you might consider
annuities
specially structured for ETF portfolios.
5. Minimize Company Risk by using our "buy countries, not
stocks" strategy. Instead of trying to pick the best three
stocks on the Tokyo Stock Exchange, why not just minimize
company risk by buying the iShares MSCI Japan Index, which
tracks the Nikkei 225 and spreads this risk across 225 Japanese
companies.
6. Monitor ETF Country And Company Exposure: Be careful to look
under the hood of ETFs to see where your money is going. For
example, let's look at the iShares MSCI Emerging Markets ETF. It
invests in 26 different countries, so it is natural to think
that you will get broad exposure to all 26 countries. You would
be wrong: 50% of your investment in this fund is going to four
countries: South Korea, South Africa, Taiwan and China. In
addition, incredibly, 7.5% is going to one company, Samsung
Electronics of South Korea.
The same is true for the MSCI Europe, Asia and Far East index.
It contains 21 developed countries, but 48% of the money you
invest would go to just two: Japan and the United Kingdom.
Meanwhile, less than 1% would go to Singapore and Ireland!
Country specific ETFs such as the new iShares FTSE/Xinhua China
25 Index can also have a fair amount of concentrated risk.
Although the China ETF tracks a basket of 25 companies, the
largest five companies account for nearly 50% of your exposure.
7. Cut Losses With A Trailing Stop-Loss Policy And ETF Put
Options: We have all been there. You buy a stock or fund, and it
appreciates in value rapidly. Then it stumbles and begins to
decline. What do you do? Should you buy more, let it ride, or
sell? Save yourself a lot of pain and agony by following a
simple rule. If a position ever falls more than 20% from its
high, sell it immediately and reassess the situation. If you
invest in an ETF with a sizable downside risk, why not spend a
few hundred dollars to purchase a put-option as an insurance
policy?
8. Rebalance Your Portfolio: At least annually, you need to make
some changes so that you are not overly exposed to countries
that have higher risk factors and volatility. One way is by
selling some shares of your winners and increasing exposure to
under performers. This accomplishes another goal, locking in
gains and taking some money off the table. Remember, only a fool
holds out for top dollar, especially in the more volatile
emerging market countries.
Building your portfolios with low-cost, tax-efficient ETFs is a
smart strategy, but don't set it on auto pilot.
For more information go to http://www.chartwellasia.com or call
877-221-1496
About the author:
Carl Delfeld is head of the global advisory firm Chartwell
Partners and editor of the the "Asia-Pacific Growth" newsletter.
He served on the executive board of the Asian Development Bank
and is the author of "The New Global Investor." For more
information go to http://www.chartwellasia.com or call
877-221-1496.
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