All Weather Investing With ETFs

After two bear markets in the first 10 years of the 21st Century,
investors now seem to understand that stock market losses can be deep.
Bonds offer relative safety, but low yields may not offer enough
income for many investors who are worried about stock market
volatility. all weather investing looks beyond the typical
stock/bond/cash portfolio in an effort to benefit from market gains,
while seeking some protection of capital on the downside.

*TUTORIAL:* Exchange-Traded Funds
A History
When stock markets dipped in the 1990s, analysts called it a
correction and individual investors viewed it as a buying opportunity.
From 1982 through 1999, buy-and-hold had been the king of investment
strategies, as the S&P 500 delivered an annualized return of over 18%.
Stock investors were reminded of the meaning of risk in the next 10
years, as those two bear markets led to an annualized return of -0.99%
a year through the end of 2009. Realizing that financial storms can
disrupt retirement plans, some investors considered the safety of
bonds to provide steady income, unfortunately triple-A corporate bond
yields were falling over that same time and yielding only 5.31% on
average at the end of 2009. Safe Treasury bonds hovered near 3%.
In this environment, some investors became familiar with the idea of
all weather investment strategies, which are designed to capture
steady gains and limit volatility. The unpredictability of returns is
one definition of volatility. When stocks fell more than 50% after the
top in 2000, many 401k investors were forced to rethink their
retirement plans. The recovery that began in 2002 had some investors
back to where they started in five years, but the declines of 2008 and
2009 presented yet another setback, and many portfolios ended the
decade at about the same level as where they stated.

Volatility can be decreased by diversification. One of the simplest
all weather techniques is to create a balanced portfolio with 60%
invested in a broad stock market index fund and 40% invested in bonds.
During the lost decade that ended in 2009, one study found that this
approach would have yielded an annualized average return of 2.6% a
year.

*Current-Day Analysis*This shows that adding asset classes can help to
reduce risk. Unfortunately, many investors have failed to consider
options besides stocks and bonds. Even the most adventurous may
include a fixed allocation to gold and consider themselves
well-diversified. Exchange-traded funds (ETFs) offer individual
investors access to markets all over the world, and some of these
funds offer access to asset classes that once required large
investments. Perhaps most importantly, global asset class
diversification could have helped deliver profits in the first decade
of the 21st Century.

Broadly speaking, there are at least 12 different asset classes –
U.S. large-cap, mid-cap and small-cap stocks; foreign stocks in
developed and emerging markets; corporate, government, foreign and
inflation protected bonds; real estate; money market and commodities.
ETFs can be used to access each of these classes.

*Ask the Experts*Dr. Craig Israelsen, a professor at Brigham Young
University, has shown that buying those 12 different classes can help
investors achieve average returns that almost match stock market
returns while having about the same level of volatility as an all bond
portfolio. He maintains a part of the portfolio in cash, and found a
model portfolio would have doubled in value using ETFs. This result
relied on monthly rebalancing, restoring each position to their
original allocation percentages at the end of each period. He also
shows that less frequent rebalancing, done even as seldom as annually,
can beat a simple buy-and-hold investment in stocks.

Nobel Prize winning economist Burton Malkiel studied a diversified
mutual strategy and found that an investor could have almost doubled
his money from 2000 to the end of 2009 by using index funds. He looked
at broadly based, low cost index mutual funds that focused on U.S.
bonds, U.S. stocks, developed foreign markets, stocks in emerging
markets and real estate securities. ETFs can offer lower costs to
access each of these areas. That is a significant advantage to the
long-term all weather investor. An ETF expense ratio may be half as
much as the expense ratio of a mutual fund and the difference in
expense ratios increases annual returns.

The work of Mebane Faber demonstrates that moderately active
management can help investors avoid the worst of bear markets. Faber
looked at five asset classes – U.S. stocks, foreign stocks, real
estate, commodities and the U.S. 10-year Treasury bonds. He used a
simple buy rule, holding the asset only when it was above its 10-month
moving average. The moving average is designed to look beyond the
short-term trends within price data and help investors spot the
longer-term trend. Faber's study assumes that you only own the asset
class when it is on a buy signal. When prices fall below the 10-month
average, you move to cash for that portion of the portfolio. The
results are impressive, an average annual return of 11.27% from 1973
through the devastating bear market of 2008.

To implement any of these strategies, a wide range of ETFs can be
used. Some examples include:
* U.S. large-cap stocks: *SPDR S&P 500* (NYSE:SPY)
* U.S. mid-cap stocks: *Vanguard Mid-Cap ETF* (NYSE:VO)
* U.S. small-cap stocks: *Vanguard Small Cap ETF* (NYSE:VB)
* Foreign stocks in developed markets: *Vanguard Europe Pacific ETF*
(NYSE:VEA)
* Foreign stocks in emerging markets: *Vanguard Emerging Markets
Stock ETF* (NYSE:VWO)
* Corporate bonds: *Vanguard Total Bond Market ETF* (NYSE:BND)
* Government bonds: *Vanguard Intermediate-Term Government Bond
Index Fund* (NYSE:VGIT)
* Foreign bonds: SPDR *Barclays Capital Intl Treasury Bond*
(NYSE:BWX)
* High yield bonds: *iShares iBoxx High Yield Corporate Bond*
(NYSE:HYG)
* Real estate: *Vanguard REIT Index ETF* (NYSE:VNQ)
* Commodities: *PowerShares DB Commodity Index Tracking* (NYSE:DBC)
*Conclusion*There are many other ETFs that can be used. Rebalancing
can be done as little as once a year, as shown by Israelsen, or once
a month, as shown as by Faber. Either way, all weather investing can
be done in a relatively low maintenance portfolio. (For more
information, take a look at _Rebalance Your Portfolio To Stay On
Track_.)
*by Michael Carr*,CMT (Contact Author | Biography)
Mike Carr, CMT, is a member of the Market Technicians Association and
editor of the MTA's newsletter, _Technically Speaking_. He is a
full-time trader and writer.
Source: Investopedia.Com