Investing in Risk Based ETFs

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 |  Includes: AOA, AOK, AOM, AOR
by: Kyle Waller

So what do we do when we come to the conclusion that we can not effectively time the stock market and that constantly buying and selling stocks, bonds, ETFs, and mutual funds is not an effective strategy? We diversify. I want to also add that diversifying through ETFs is a very cost effective way to do this. ETFs seem to be the most effective and complete way to maintain the investing strategy of indexing which in essence is creating a highly diversified, passively invested portfolio.

What holds many back from having a very successful indexing strategy using ETFs is getting distracted by the interesting and exotic ETF offerings, giving the investor exposure to foreign and domestic niche markets and asset classes. I think many of these newer ETFs provide value to a portfolio but too often become over-weighted because of the promise of historical performance and historical correlations to the overall market.

Something that I think is flying under the radar is the introduction of iShares S&P Target Risk ETFs. This is an area that has no previous ETF exposure. The target risk ETFs, listed below, each track an S&P Target Risk Series Index.

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Made for Success?

These risk based funds like the very similar iShares target date funds, are created by surveying other actively managed risk based mutual funds and using the aggregate of their asset allocation decisions, then using ETFs to match those asset allocation decisions. If indexing is indeed the better strategy in each of the asset class categories, all these risk based funds need to do is continue to have the lowest total cost. Simply, they will beat the average of their mutual fund peers.

The Passive, Passive Strategy

The target risk based ETFs can solve the problem and tendency for investors to chase after trends and fads in the investing universe, especially in so called passive indexed portfolios. The expense ratios include the cost of the underlying ETFs and represent the category average mutual fund’s asset allocation decisions while avoiding stock selection and market timing risks.

This leaves investors with only one decision, their risk level. There are many resources for figuring this out and the ETFs themselves, being very transparent with their allocations and holdings can send investors very clear signals on the suitability of each fund.

A New Dawn for ETFs?

These new ETFs no doubt will allow for an easier transition into 401k plans and dollar cost averaging strategies used by investors saving for retirement. Now the trading cost of buying many ETFs can be reduced to one. These ETFs give the advantage of professional allocation strategies and the intelligence of indexing while reducing trading cost and the risk of over allocating trends in the ETF industry.

Disclosure: no positions

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