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October 19, 2017

The Hard Way is the Right Way

You’ve probably noticed that I’ve spent a lot of time over the past six weeks talking about ETFs.

• I talked about individual investors perhaps unwisely using ETFs to mimic the behavior of macro portfolio managers.

• I talked about how low transactions costs on ETFs sometimes lead people to make suboptimal decisions.

• I went over in detail how to select an ETF from an array of choices.

• I talked about ETF ticker clutter, and how the proliferation of ETFs has made the job of selecting one more difficult.

• I talked about smart beta and ETF liquidity.

• And I talked about the philosophy of indexing in general, and how when indexing is taken to extremes, it causes distortions.

This is a pretty good summary of the thinking on the current state of the ETF industry—if you haven’t read these pieces, I suggest you check them out.

And of course, my new ETF-focused newsletter, ETF 20/20, launched on Monday. The response has been overwhelming, which shouldn’t be a surprise. Imagine being coached on building a diversified ETF portfolio by an ETF expert—at a cost of a dinner for two at Applebee’s. Including drinks.

People say ETFs are cheap, and ETF advice, like robo-advisors, is cheap. This takes it to another level.

I am motivated to do this out of a sincere desire to help individual investors. It’s something I’ve wanted to do since 2003. The tricky thing about investing is that if you go to Barnes & Noble and look at the Personal Finance section, you will see a lot of book titles that lead you to believe investing is easy. 12 Easy Ways To Do This, 7 Easy Ways To Do That.

That’s a lie. Investing isn’t easy. It’s one of the hardest things you’ll ever do. And it’s hard because there are no answers! Right now, the answer seems to be plow money into the Vanguard 500 Index Fund. But what if that isn’t the answer going forward? What if the market environment changes?

And that is why investing is hard—you have to learn how to play a game in which the rules constantly change.

So this is more than just about picking some ETFs, slapping them in a model portfolio, and selling a newsletter. This is about teaching you to be intellectually flexible.

Which is the hardest thing in the world to do.

Here’s what we will try to do in ETF 20/20:

• We will build a diversified portfolio…

• That will grow over time.

• Maybe not faster than the S&P 500…

• But certainly with less volatility—much less.

That last bullet point is the most important part, because volatility is scary. My guess is that most S&P 500 index fund investors have lost perspective on how volatile the stock market can actually be. Most of the time, it’s practically unsuitable for individual investors.

ETF 20/20 isn’t “7 Easy Ways To Build A Portfolio With ETFs…” because there are no easy ways. I’m not gonna lie to you.

All I offer is about two decades’ worth of mistakes—and of course, almost two decades of being an index guy, with lots of technical expertise.

Answers

In the last few weeks, I’ve received some good questions about ETFs and ETF 20/20. I’ve answered some of them by email, but I thought I’d take this opportunity to answer a few more:

From Kevin M.: [Is] ETF 20/20 For beginners or experts?

ETF 20/20 is good for anyone who is struggling with finding the right asset allocations. That definitely includes beginners, but a lot of experts, like financial advisors, find themselves in the same position.

A lot of the conventional wisdom on asset allocation goes like this: 70% stocks, 30% bonds, you’re done. But there’s a good chance that that simplistic approach will be insufficient going forward. Not many people are putting a lot of thought into cross-correlations across asset classes. This is the stuff that I think about every day.

Beginners will learn about how ETFs work and the basics of building a portfolio. Experts will learn to approach asset allocation in a way they hadn’t considered before. Everybody wins.

From George R.: How do retirees hedge their portfolios when they feel they can't ride out the next correction?

This is a question that lots of people are struggling with right now.

The best way to hedge an asset is to simply sell the asset. Some people feel like they have to be fully invested… for some reason? I don’t know. To keep up with your neighbors? This is a bad reason.

For people in this position, with both stocks and bonds as overvalued as they are, you really have to think hard about what belongs in your portfolio and what doesn’t.

Now, there are ways to hedge, but there is a cost. You could simply short an index ETF like SPY or IWM. I know you are thinking—why not buy an inverse ETF? Please do not do that, for reasons I have described here.

You can also buy out of the money put options on an index ETF, like SPY. But there is a cost associated with doing that. And then there is the issue of timing—if you hedge with options, and the market moves higher and then options expire worthless, you are not going to be as excited about hedging the next time around.

I prefer to keep it simple—lighten up, move to cash, buy cheaper assets.

From Mike K.: Is it foolish to have a portfolio composed entirely of ETFs, assuming those ETFs are appropriately diversified? Do you really need individual positions now?

I’m not the only one building portfolios strictly of ETFs—robo-advisors are doing it as well.  You know how robo-advisors work—you give them your money, and they quantitatively allocate it across an array of lost-cost ETFs. They charge you about 25 basis points for the privilege. Here is the amazing thing about ETF 20/20—we are doing the same thing, and possibly better, for just $39. And I can make a pretty good argument that my asset allocation skills are better than the roboadvisor quantitative model.

ETF 20/20 is the newsletter I’ve wanted to start since 2003. In my other letters, I help complicated people do complicated things. ETF 20/20 is for everyone.

If you’re new, and you need help building a safe, diversified portfolio, it is for you.

If you’re an expert… and you need help building a safe, diversified portfolio, it is for you.

And we’ll have some fun along the way.

You might want to think about signing up now. If you put it off until you get home tonight, you might forget.

Jared Dillian
Editor, The 10th Man

Jared's premium investment service, Street Freak, is available now. Click here for our introductory offer. Jared Dillian, former head of ETF Trading at one of the biggest Wall Street firms and author of the highly acclaimed books, Street Freak: Money and Madness at Lehman Brothers , and All the Evil of This World , shows you how to pick and trade trends, and master your inner instincts. Learn how to use “Angry Analytics” as a leading indicator of budding trends you can profit from… and how to view any market situation through the lens of a trader. Jared’s keen insight into market psychology combined with an edgy, provocative voice make Street Freak an investment advisory like no other. Follow Jared on Twitter at @dailydirtnap.

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