“The S&P 500 index is worth about 75% of an ounce of gold, verses a peak of more than five times the value of gold in 2000 when the S&P peaked at more than 1,500 and gold languished around $300 an ounce. Over the past 40 years, the S&P has averaged 1.6 times the value of an ounce of gold.”

Gold and other precious metals are an interesting investment and have gained a lot of press recently through radio and TV advertising. As the stock market has been severely affected by the credit crisis, gold has been seen as a ‘safe’ investment that never loses value like stocks and bonds because it is gold; the asset that was once was used to peg many currencies including the U.S. during the time of the gold standard.

2008 was a year of realized risk among many asset classes. It followed a period of lower volatility in many asset classes, like foreign developed and emerging markets. The foreign developed market index, EAFE (Europe, Australasia, and Far East) is held by many US investors through the iShares ETF, EFA. The appeal of this kind of investment and asset class is its diversification benefits. However, the risks of the EAFE index encompasses currency risk that many investors fail to incorporate into their risk assumptions.

Commodity ETFs and ETNs have come a long way in recent years, allowing investors to gain exposure to many commodity indexes ranging from very broad to very narrow. The recent downfall of Lehman Brothers (LEHMQ.PK) left the holders of their ETNs out of luck holding the unstructured debt. The risk of ETNs is apparent and one can pass over this risk by instead investing with ETFs. However, ETFs in the commodity space may not be worth the extra security for some investors.

ETNs are promissory notes issued to represent and give the return of ownership of a currency exchange, commodity, and any asset that poses a barrier for others to invest directly into for a fee they receive through an expense ratio. The key difference is that ETNs do not have to hold the underlying assets but instead are like a bond, promising return but representing no ownership The appeal of these investments is the ability to gain easy access to unique assets or investment strategies.

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.

The small cap asset class has performed well over the last decade and has done relatively well during this current bear market.  Typically, one would expect small cap businesses as an asset class to be affected worse than large businesses in slowing economies since they have less diversified revenue sources, are not as globally diversified, and have a harder time raising capital.  Small cap funds have been hurt this year, but not as much as the riskiness of the asset class would predict.  

However, among small cap ETFs, performance has varied widely when comparing the three ETFs that are linked to three popular small cap indexes, iShares S&P SmallCap 600 Index ETF (IJR), Vanguard Small-Cap ETF (VB) and iShares Russell 2000 Index ETF (IWM) are linked to the S&P Smallcap Index, the Russell 2000 Index, and MSCI the U.S. Small Cap 1750 Index respectively.