ETFs and Asset Allocation

ETFs and Asset Allocation
Here is a question investors should be asking themselves more often.....

Why pay expensive fund managers if they cannot protect your money when it most needs protecting?

One way to avoid paying high fees to managers that do NOT perform is through the use of index funds, which passively follow an index. But until recently index funds were pretty much limited to ones which track the performance of the major stock market indices, such as the S&P 500 index.

However, the growth of exchange traded funds (ETFs) has radically changed the face of index investing, giving investors low-cost access to a wide range of investment opportunities across a suite of asset classes. These asset classes include: equities, fixed income, international stocks and bonds, real estate, currencies, commodities and gold.

Investors should bear in mind, however, that investing in an ETF does not remove the risk of losing money, as an ETF will simply follow whichever index it tracks up and down. But ETFs do remove the risk of paying high fees for terrible performance.

The low cost of ETFs is one of their biggest attractions. In the United States, investors pay an average of 0.17 per cent of assets under management a year for an ETF following a broad equity market index.

Other advantages that ETFs have include transparency, simplicity, flexibility and liquidity. ETFs can be bought and sold at a specific price (very near the net asset value) on a stock exchange at any time the exchange is open, much like a stock. This is sharp contrast to a mutual fund, which is only priced at day's end and investors can't be sure what price they paid for the shares.

ETFs are therefore a very useful tool for investors, as ETFs allow investors to easily gain exposure to a sector or asset class with the purchase of a specific ETF. However, ETFs are just a tool – the key to positive investment performance still remains the decision by investors as to which asset classes should be in their portfolio.

I have discussed in prior articles some of the asset classes that should be a part of every investor's portfolio. Of course, there will be varying percentages allocated to each asset class due to differences between each investor – age, risk tolerance, goals, etc.

In my humble opinion, the problem with many investors' portfolios has been too many 'eggs' in one basket – that is, far too much money devoted solely to the US assets denominated in US dollars.

I firmly believe that most investors should have at least some exposure to the following:

1) International stocks, particularly the emerging markets such as China and Brazil

2) International bonds, to diversify out of the US dollar for your fixed income holdings

3) Commodities – in other words, real assets as opposed to paper assets, either through commodities themselves (ETFs) or stocks in commodity firms

4) Currencies (again with ETFs) – the US dollar is in long-term decline, having lost nearly 70% of its value since it was taken off the gold standard

5) Real estate, but real estate like farm land or timber – again real assets

6) Gold – this is a whole separate category – gold should be treated as financial insurance, to protect against financial calamities, much as you use your health or homeowners insurance

If you have any specific questions or comments about this article please feel free to contact me directly via email or in the Investing forum.

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