Building your portfolios with low-cost, tax-efficient ETFs is a smart strategy but don’t set it on auto pilot. Follow these 10 ETF investment rules to build a global portfolio that will beat the benchmarks:
The comments above & below are edited ([ ]) and abridged (…) excerpts from the original article by Carl T. Delfeld (ChartwellETF.com)
1. Liquidity 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. If you have a long-term perspective, you might consider annuities specially structured for ETF portfolios as your core portfolio.
3. Think Global and 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 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 US 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 the dollar strengthens in 2010, EUM might be a good hedge as more speculative markets will likely take a hit. 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. While a rising tide does tend to lift all boats – some soar and others lag. In 2009 for example, while Russia (RSX), Brazil (EWZ) and Peru (EPU) were up over 100% in dollar terms through early December, Japan (EWJ) and Switzerland (EWL) were up less than 15%.
4. Be Careful What 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.
Know what drives specific markets. Chile (ECH) is dependent on copper prices, Austria (EWO) is a banking play on Eastern Europe, Russia (RSX) is highly focused on oil and natural gas and South Korea (EWY) is increasingly integrated into China’s economy.
5. Look Forward, Act Now
Keep in mind that the quality of the countries you choose to invest in is critical, but overreaching when valuations are high is hazardous. 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. Timing and trends are key.
6. It’s the Politics
Many otherwise astute investors fail to recognize the importance of politics in global investing. Political change cuts both ways and can present great investment opportunities. Most great bull markets begin with significant economic reform. In emerging markets, regulatory and political risk can swamp traditional portfolio analysis.
Who can dispute that India’s election this spring ignited a tremendous rally or that the clear and commanding re-election of President Yudhoyono better known as SBY in Indonesia contributed mightily to the 100% plus surge of its market in 2009.
7. Minimize Company Risk:
By using our “Buy Countries, Not Stocks” strategy, you minimize company risk. Instead of trying to pick the best three stocks on the Tokyo Stock Exchange, why not just minimize company risk by buying the Japan iShare ETF (EWJ) that tracks the Nikkei 225 and spread this risk amongst 225 Japanese companies. Or you could hedge your bets and do both. Japan has lagged in 2009 but if the Japanese yen weakens in 2010 (as I suspect) EWJ and the inverse Japanese yen ETF (YCS) will soar.
If you, like me, enjoy picking stocks and blending them with ETFs – consider putting them in a basket as part of your growth portfolio.
8. Monitor ETF Country and Company Exposure:
Be careful to look under the hood of ETFs to see where your money is going…Many country specific ETFs…can have a fair amount of concentrated risk in surprisingly few companies.
9. Manage Risk and Cut Losses with Trading Signals, Trailing Stop Loss Policy or 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 8%-12% from its high, sell it immediately and reassess the situation. And 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?
Choose and follow a trading signal that indicates that markets may be reversing. When broad ETFs such as SPY and EFA fell through their 200-day and 50-day moving averages in July of 2008, moving to cash, bonds or inverse ETFs would have saved your portfolio a bundle.
10. Consider Rebalancing and an Annual Portfolio Check-Up:
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.
Just like your annual physical, it is wise to get an annual portfolio review to make sure you are on track to meet your financial goals. Sure, there will be false signals – better safe than sorry.
Building your portfolios with low-cost, tax-efficient ETFs is a smart strategy but don’t set it on auto pilot.
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