Asset Allocation ETFs: Low Expenses Are Nice, Losing Less Money Is Nicer

I'm a big fan of the folks over at Index Universe. Like myself, Matt Hougan and Jim Wiandt have been at the forefront of the inevitable exchange-traded fund revolution.

Nevertheless, there are times when Mr. Hougan's penchant for simplification can undercut a darn good argument. Let me explain.

Every now and again, the Index Universe principal puts together diversified portfolios that capitalize on low expenses alone. Here is the latest:

Index Universe: Low Expense Ratio Portfolio
				Weight	Expense Ratio
Vanguard Total Market (VTI)				40%	0.07
Vanguard Europe Asia Pacific (VEA)				30%	0.12
Vanguard Emerging Markets (VWO)				5%	0.25
Vangurd Total Bond Market (BND)				15%	0.11
Vanguard REITs (VNQ)				5%	0.12
iPath Dow Total Commodities (DJP)				5%	0.75
Blended Expense Ratio					0.1365

Yes, it is noteworthy, and genuinely important, that one can get access to a diversified mix of stocks, bonds, REITs and commodities for less than 0.14% annually. The average ETF investor may pay closer to 0.45% per year, while the average mutual fund investor may pay 1.4% per year.

Indeed, one of the greatest benefits of ETF investing is the cost structure. All things being equal, the lower one's investing costs, the higher one's investment returns.

What's not mentioned here is the ghastly investment returns such a buy-n-hold grouping delivered in 2008 alone. In 2008, this portfolio lost in the neighborhood of -40%. A 40% loss requires a 67% gain to recover. Historically, for this portfolio, that may mean a 5-7 year waiting period.

Granted, ETFs are the right vehicle for accessing stocks, bonds, currencies, commodities and real estate at the lowest cost costs possible. Moreover, lower investing costs are one of the big reasons ETFs are the best way to invest. But ETFs offer so much more!

For starters, ETFs offer one the ability to manage downside risk. Aren't you tired of hearing folks talk about an inability to "time" the market? So you're just supposed to sit around and watch your money disappear? Puhhhhhlllllleeeeeeeeeeease.

ETFs are diversified funds that trade like stocks. And since risk is measured on the downside -- risk being defined as the possibility of loss -- one must actively protect against excessive losses. This is very easy to do with ETFs and individual stocks... simply by using trailing stop-loss orders.

Inevitably, someone asks, "So when do you get back in?" Who says you have to buy the exact same ETF? Maybe you will purchase something entirely different immediately. Hundreds of ETFs are available to look at and evaluate. Or maybe you will use the same stop-loss percentage off the low that is reached after you have sold.

Look, don't be brainwashed into the notion that you can't sell for tax reasons, or that some magical allocation is appropriate for your age and so-called risk tolerance. ETFs are not merely cost-management tools, they are risk-management tools. Understand risk better and you will manage it better, through dozens of techniques that do not make you an evil market timer.

Even if you insist on buy-n-hold, lazy portfolios, I've got one that you may find less risky. In essence, I'm a big believer in capturing income and dividends, yet another benefit of the astute ETF analyst.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Comments

[User 305589:]

oh my god!
long-term superior performance with ETFs?? really. hm. how come?
by the right 'asset allocation mix' ? But, uh, wait, you have to be smart in market timing then, no? because otherwise, you can well end up losing performance by shifting in and out of certain asset classes instead of gaining anything.
trailing stop-loss, great - or maybe not? how often do people get stopped out for a 20 or 25 or 30% loss only to miss the re-entry or to see the market turning around a week later. your advice in that case is just hillarious: 'you could buy another etf, or the smae and use another stop-loss' brilliant, what a genius. here we have someone who claims to have found the holy grail of smart invbesting - using etfs and stop-losses.
oh my, if he just could prove that claim.

a totally useless promotion for etfs and your website.
thank you very much for wasting other people's time.

Jan 13 05:58 AM

[ikkyu:]

You call yourself "at the forefront," "astute," and an "expert" yet you also claim that ETF's are the "lowest cost possible" way invest in currencies?

You might want to read up on that.

Jan 13 08:40 AM

[pantograph:]

For the vast majority of investors: more trading equals lower returns. That includes people who pay an advisor to churn their holdings trying to time the markets. They not only lose money trading, but pay a fee for the privilege. No thanks.

Jan 13 12:42 PM

[donzelion:]

I love this sort of strategy - an evolutionary tweak over the classic "couch potato" strategies.

What do you think of my proposed tweaks?

(1) Asset location. VNQ and BND go in tax-managed accounts (IRAs). Foreign stocks go in taxable accounts. Way I understand it, this will minimize the tax hit and maximize the foreign tax exclusion.

(2) Buy through limit orders - "market-timing lite." Buy the allotment to each ETF in a single bloc with a limit price 8% below the current price on target allocation day. If any ETF doesn't hit over the next quarter, then adjust the limit price to 8% under the price on that day. Benefits: limit capital gains taxes from selling to rebalance, limit downside risk slightly (8% per ETF adds up), and you'll earn interest from a sweep account (for brokers like Sharebuilder). Costs: takes longer, you'll miss some upside for surging ETFs that don't have any pullbacks, and you'll miss out on dividends.

(3) Consider DEM over VWO. I'm not certain I buy the argument for dividends-weighted indexes in the developed markets, but in the emerging markets, information is scarce and unreliable. In such environment, payouts speak louder than market cap.

What do you think?

Jan 13 01:00 PM

[Geoffrey Lordi:]

Donzelion,

Regarding your third point, there's also something to be said for DEM's outperformance over VWO. As a previous VWO owner - and "praise singer" - I switched because I felt DEMS's higher fees were justified. And I've been rewarded since converting: DEM has outperformed - buy a reasonably substantial margin - VWO over the past 1m, 3m, 6m, 1yr, and since DEM's inception (July 13, 2007). This has more than paid for the fee difference - .63% vs .25%. Oh - and I love the dividend on DEM, too: 5.98% vs. 5%.

Jan 13 02:37 PM