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ETFs One Year Later

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Buy and hold is dead. Is it time for a second look at ETFs?

Everything looks different since iMoney: Profitable Exchange Traded Fund Strategies for Every Investor was published in June of 2008.

Within months of the book’s publication, the stock market collapsed, and is now crawling its way back to normalcy. Securities of nearly any type – stocks, ETFs, mutual funds – began losing assets to varying degrees. Major financial institutions crumbled, not least of which was Lehman Brothers, which many believe really kicked off the financial crisis as we know it.

What was taking place on the world stage touched millions of investors of all types. There were those who had never before thought about the markets. Those investors long ago selected a 401(k) plan, determined an amount to contribute each month and then promptly set it aside. After all, they had been told that buy-and-hold was the way to go. The common wisdom was that markets trend up over time.

These investors were hurt the most when the markets collapsed. It wasn’t unusual to hear about portfolios and 401(k)s that lost 40% or more of their value. Believing that hanging on through the ups and downs of the markets would ultimately pay off in the long run, buy-and-hold investors hung on for a stomach-churning ride until many of them finally let go and suffered huge losses.

This market collapse and the rebuilding process in the last year and a half has led to some major changes, particularly in two ways:

  1. It’s dented the notion that buy-and-hold is a foolproof investing strategy
  2. It’s contributing to the growth of the ETF industry, thanks to burned investors looking for a new way

Buy-and-Hold Is Dead

Buy-and-hold is a strategy that no longer works. Millions of investors hung on tight throughout the crisis, until it reached an inflection point and they sold, absorbing their already substantial losses. Those investors are not alone, though: even investing guru Warren Buffett lost $16 billion in 2008, illustrating how detrimental this strategy can be in a period of crisis in the markets.

Had you invested in the S&P 500 in 1997 and held onto it through all the ups and downs until earlier this year, you would actually be below where you started. In the end, this equates to more than 10 years of investing with not much to show for it outside of dividends. And you’re 12 years closer to retirement.

We’re living in different times. The global economy of today is not the global economy of 50 years ago. The way the world works now requires a more hands-on approach. The good news is that with some discipline, time and practice, investors can step in and not only have their portfolio in areas that are moving, but keep their portfolio on the sidelines in major market corrections in order to protect gains or limit losses.

The markets have definable trends, and by simply learning to spot these trends using the 200-day moving average, investors will be much better served.

This is the reason I wrote my follow-up to iMoney this summer, The ETF Trend Following Playbook. The global financial crisis has led to a sea change in the markets, and investors not only have to take control of their portfolios and step in at times, but they want to. No one wants to suffer the kind of losses that so many people did in 2008-2009 ever again. The trend following method is an easy-to-understand one that gives investors the tools they need to identify trends and profit in both up and down markets.

The ETF Industry

As the markets have recovered, investors aren’t simply returning to their old standbys. Many of them have been returning and investing in ETFs because of their benefits over mutual funds, including:

  • On average, they’re cheaper than most mutual funds
  • They trade all day on an exchange like a stock
  • They’re transparent – you always know what you’re holding
  • They’re tax-efficient – because of their structure, they rarely generate capital gains

As of August 2009, assets in ETFs climbed nearly 13% year-over-year. In response to growing investor demand and the knowledge that trillions of investor dollars are now sitting on the sidelines, the number of listed ETFs has climbed to nearly 800.

While assets grow, we’re seeing the ETF industry grow and change, as well. The end result is a much different picture from a year ago. Some of the newest developments we’ve seen in the last year include:

  • Actively managed ETFs continue to appear. In addition to PowerShares, which launched the first actively managed ETFs available, Grail Advisors launched a line of actively managed funds. Allianz, Claymore, State Street, AdvisorShares and Vanguard all have filed with the Securities and Exchange Commission (SEC) to issue their own active ETFs.
  • Mergers and acquisitions. One of the biggest stories in the world of ETFs is that iShares, the world’s largest provider, was purchased by BlackRock. The deal made BlackRock the world’s largest asset manager. Globally diversified institutional manager Guggenheim also bought Claymore in July.
  • Major names are entering the ETF space. Bond giant PIMCO has launched several bond ETFs, Charles Schwab has filed for some asset class ETFs, and TD Ameritrade has expressed an interest in getting into ETFs.
  • New names have come on board, such as RevenueShares, Global X, Javelin, Jefferies, Emerging Global Shares and OOK Advisors. ETF Securities, a leading provider in Europe, is rolling out a line of physically-backed ETFs here in the United States.
  • More coverage of emerging markets. Emerging markets have been leading the way out of the global recession so far this year, which has led to a slew of new offerings to cover the space. Among the launches include a long anticipated Vietnam ETF from Market Vectors, a Peru ETF from iShares and a Colombia ETF from Global X. There are also emerging market sector ETFs – three from Claymore are in registration, and Emerging Global Shares has several trading now.

Now that the economy appears to be on the right track and investors are wading back into the markets, the ETF industry will continue to grow and change in interesting ways. It’s my hope, too, that investors will not only utilize ETFs, but embrace them as the tools they need to take charge of their portfolios to avoid suffering the kinds of losses they did in the last year.

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