WASHINGTON. As we indicated in our previous column, while an astute individual investor can still “beat the averages,” at least on occasion, it’s increasingly tough to do so in a universe of stocks where large averages and even smaller sectors tend to move in lockstep. This makes it far safer to invest in a basket of stocks represented by a given ETF, rather than try to choose only the big individual stock winners that may stand out within the index. Hence, this column, which describes our process of ETF Perestroika.
In short, ETFs are the revenge of the mutual fund industry. They’re basically mutual funds that trade like stocks. They give you the advantage of investing a modest amount of money in a vast portfolio like the rich guys. But they lack the massive front-end loads (commissions) that many mutual funds used to charge. (And some still do.)
Better yet, trading with a given brokerage house generally gives you access to a large number of excellent ETFs without any commission at all. That means that you can increase the size of your ETF investments in tiny increments – important in this era where the term “stock split” seems to have become anathema, making many stocks too expensive for the little guy to invest in “round lots” (100 shares), the traditional way we all used to invest.
Lacking even nominal commission charges – and also often benefiting by extraordinarily tiny management fees – small investors can lessen risk (generally) and increase returns by accumulating ETFs at opportune moments in bits and pieces.
Then, by putting them on mostly non-commission-charging dividend reinvestment status, small investors can continue to dollar-cost average while increasing the size of their portfolios, generally without much worry. That’s the reasoning behind what we’re currently trying to do with our own mediocre-performing portfolios. And the strategy appears to be working for us.
Given the current media fixation on all things Russian, we’ve decided to call our developing investment strategy ETF Perestroikain honor of the Soviet Era Russian term for “restructuring.”
The term “perestroika” popularly circulated on this side of the Atlantic during the Reagan Era when superpower détente with Mikhail Gorbachev and the Russians first became a real possibility. (Perhaps it could become a possibility again. (But we digress.)
As it pertains to our investment portfolios, ETF Perestroika does not involve any collusion whatsoever with Vlad “The Impaler” Putin, Russian oligarchs and/or the Russian mafia. Instead, our ETF Perestroika strategy has the following goals.
- In an orderly manner, shift between 40 and 50 percent of our holdings to stock and fixed income ETFs.
- Invest approximately 25 to 30 percent of our holdings in preferred stocks, select CEFs (closed-end funds), REITs and MLPs.
- Invest the remainder of the portfolio primarily in bonds and individual special-situation stocks, leaving a moderate proportion of this piece in cash to better take advantage of IPOs or additional special situations as they happen.
Simple, easy. But ETF Perestroika takes time. Right now, we are close to our goal percentages. But we remain substantially overweight in Allergan and Alibaba. We plan to avoid unforced errors like this in the future. We see no point in dumping these big positions for losses at the moment. They should recover over time and lead to eventual profits. But both stocks will continue to weigh on our portfolios for some time to come.
We should have spread out the risk more evenly. But everyone makes mistakes. But that’s part of the reason we offer these columns. Like everyone else, we screw up sometimes. But we learn from our mistakes. Anyone who brags to you that they’ve been coining money in the market for years and never loses money is, de facto, a liar. Ignore the braggart. After all, we get enough fake news these days.
Making a mistake isn’t dumb in the end so much as it is a learning opportunity. So learn and move on.
ETF Perestroika: The strongest path to ETF Nirvana
As most advisors will tell you, diversification is your best bulwark against investment disasters. That’s actually one of the main reasons we’re transitioning to the ETF route. ETFs in and of themselves provide the smaller investors with far more diversification than they can generally get on their own. A viable ETF Perestroika plan can help get you to ETF Nirvana more quickly.
There’s no denying that diversification gives big investors and high-frequency traders their edge over the little guy. So why shouldn’t us little guys take advantage of this? Particularly when you can acquire – and sell – a raft of excellent ETFs often without commission at many brokerage houses. How can you lose?
Actually, you can lose money in the best of scenarios. And, as I learned back in my old brokerage career, nothing ever carries a guarantee in the wonderful world of investing. Not even ETF Perestroika.
But at the moment, our exercise in ETF Perestroika is leading us to ETF Nirvana, our third and final topic in this series.
Next: ETF Nirvana. Our growing list of ETF and ETF-style investments.
Headline image: Reagan and Gorbachev meet. Perestroika underway. (Official U.S. Government photo. In the public domain. Image via Wikipedia entry on Mikhail Gorbachev.)