An Easy Way To Insure Against A Big Loss With Your ETFs

by: Gary Gordon

One of the more noticeable trends in the current U.S. stock bull has been the flip-flopping of the bears. Steven Russolillo at recently profiled a variety of prominent voices who received accolades in the past for extreme pessimism. Yet, even as price gains started to pile up in 2009, 2010, 2011 and 2012, these folks insisted that the moves higher would not last. Eventually, each relented; each changed course by professing bullish optimism on U.S. equities. And names that had once been uttered with reverence - Roubini, Rosenberg, Parker, Whitney, Russell, Hendry - are now being snickered at.

Believe it or not, there are a few permanently bearish prognosticators that refuse to board the ridiculously crowded bull boat. One of the biggest personalities still firmly in the bear camp? John Hussman. The manager of Hussman Strategic Growth (MUTF:HSGFX) rose to legendary status by avoiding the bulk of the bearish downturns in 2000-2002 as well as 2007-2009, racking up 7.7% annualized returns in the previous decade; the S&P 500 SPDR Trust (NYSEARCA:SPY) offered -0.8%. Unfortunately for Dr. Hussman, looking at the current 10-year period leaves HSGFX with a negative 10-year annualized return (-1.2%) and SPY with the impressive showing (7.0%).

Each of the names listed above were lauded as heroes for having predicted the financial collapse in 2008. By the same token, none of them predicted the enormous impact that unconventional central bank policy had on corporate profits, debt refinancing and market prices. Bull market admirers are equally suspect. Ken Fisher, Jim Cramer and many of the members of the Federal Reserve did not call the 2008 credit crisis. Harry Dent, Henry Blodget and Ralph Acampora not only missed the 2000-2002 dot-com blow-up, they all pushed for different valuations for the transformative "New Economy."

The lesson learned here is straightforward. There is simply no benefit to the investor for blindly following another's absolute bullishness nor bearishness. If you fail to minimize monstrous downside slides, the financial and emotional periods over time can be devastating. The Nasdaq has not recovered its highs from 14 years ago. By the same token, if you wait to participate in market-based price appreciation based on rational or irrational reasons, you're likely to spend years wondering went wrong as you sat on the sidelines.

Since market direction cannot be predicted, the media tend to push buy-n-hold laziness. The financial media get paid by financial companies with a vested interest in buying-n-holding. However, the idea that one should ignore the Nasdaq dropping by 80% is ludicrous; the notion that an investor should sit on the SPDR S&P 500 Trust (SPY) alone, regardless of 50% declines that require 100%-plus recoveries to break even is equally insane, as it ignores principles of insuring against disaster.

Investing successfully requires insurance. Stop-limit orders, trendline crosses, put options, inversely correlated hedges - reducing the pain in bad times is critical to insuring the preservation of capital and the protection of substantial price appreciation. What's more, you do not have to predict the future to decide that you should pay a small premium to protect against experiencing monster losses. In fact, you do not even need to use a sophisticated method for insuring long-term results.

Below I have listed nine of the most popular ETFs by assets. Theoretically, one could allocate all of his/her dollars to these ETFs, constructing a diversified portfolio over several asset classes. On the other hand, a risk-conscious investor who values insuring his/her success would only allocate to those exchange-traded vehicles where the current price is above a long-term trendline like the 200-day moving average.

Nine of the Most Popular ETFs Traded On U.S. Exchanges
Above/Below 200-Day
SPDR S&P 500 Trust (SPY) Above
Vanguard Emerging Markets (NYSEARCA:VWO) Below
iShares Russell 2000 (NYSEARCA:IWM) Above
Vanguard REIT (NYSEARCA:VNQ) Above
iShares Total U.S. Bond (NYSEARCA:AGG) Above
iShares High Yield Bond (NYSEARCA:HYG) Above
SPDR Gold Trust (NYSEARCA:GLD) Above
iShares TIPS Bond (NYSEARCA:TIP) Above

At the present moment, it is a good time for investors to be diversified across domestic stocks, foreign developed stocks, bonds and precious metals. The only asset that has struggled so intensely that it has not been able to hold above a long-term trendline is Vanguard Emerging Markets (VWO). Naturally, when an asset class is not doing well, media personalities (myself included) may wax philosophic about the reasons. You've heard everything from the economic slowdown in China and Brazil to runaway inflation in India to political unrest in Russia to emerging market currency pressures since the Fed's tapering decision last May. Perhaps ironically, you may need to know little more than the current price is below a 200-day trendline; sell it if you own it; do not buy it unless it climbs above its moving average.

Using the long-term moving average as a buy or sell point is far from perfect. You may get "whipsawed" when buying, as the price might fall back below shortly after your purchase. Yet even here, you can wait until a more definitive cushion emerges such as trading above the moving average for a week or a month; you might simply choose a confirming indication like a positive slope.

The point here is not perfection, but rather, a means by which one can avoid the psychological and financial hardships associated with losing a fortune in one or more asset classes. Consider how one might have insured against adverse price movement in SPDR Gold Trust (GLD). It first struggled near its 200-day moving average at the start of 2013. Using this as a decision tool for selling an asset that has been declining, one could have stepped away from GLD for roughly a year. Should one determine that the recent climb back above the 200-day constitutes a "buy signal," one would be purchasing the asset at a significantly lower price.

Selling GLD near $160 rather than hoping-n-holding as it teeters around $115 is a method of exercising control. Again, trend-based decisions are not flawless. That said, if you wish to pay a small premium to insure against the possibility (not the certainty) of a big loss, then selling a core ETF holding raises cash to reduce risk.

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Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.