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September, 2014


Suppose you could invest $1000 and get back about $1100 or more, not once, but over and over, almost without fail. If one could take the emotion out of investing and demonstrate how to do it successfully, that is, in a routine and businesslike way, odds are more of us would take advantage of the opportunities afforded by buying and selling individual securities. As it is, only 14% of us invest in stocks, closed-end funds, or exchange traded funds, and by definition, the majority of those do no better than the market averages. Oddly enough, once commissions and fees are taken into account, plus folks' often poor market timing decisions, most of us do significantly worse than the market indexes.

Online, discount investing can bring the cost of trading down considerably compared with what needed to be paid through a broker a few decades ago, and, if one would follow a few simple rules, there are reasonably safe and inexpensive exchange traded funds (ETFs) that so spread the risk from any one company having losses or going bankrupt as to make investing close to being like a money machine. ETFs are assets that trade like stocks but which usually represent market indexes, other groupings of stocks, or commodities.

Three methods are considered here, one for the long-term investor who does not care to mess with investments once purchased, the others for people a bit more into trading.

The five exchange traded funds highlighted in the table were chosen for their relatively good risk-adjusted returns and reasonably low fees associated with that performance.

They were selected after applying easy calculations and using info readily available on the web. First, one can pick the 25 or so better performing exchange traded funds which also have a several year history. Then take the average annual return of each, divide it by the fund's expense ratio, and multiply this result by the number one, less the decimal fraction representing the ETF's greatest downturn in the past ten years (which generally occurred between 9/2/08 and 3/15/09). Of the original list of 25-30 that already had decent returns, the five shown here had the highest product from these math operations and, to me, the best historical profits over the prior decade for their costs and risks.

At the table are the suggested ETFs, but if one prefers others that also have good long-term records, low fees, and relatively low downside in a bear market compared with their overall returns, switching any of these for those others would probably work out well too.

The cited exchange traded funds were competitive with the S&P 500 Index over the past decade (stats. through August, 2014): averaging 12.06% annually vs. 8.38%.

In the first approach, one simply buys a roughly equal amount of each of the five ETFs when the market is down significantly, say 20% or more (which tends to occur every few years), and holds until the assets are needed, perhaps ten, twenty, thirty, or forty years later. A buy and hold approach with an equal $10,000 investment ($50,000 total) in these exchange traded funds ten years earlier would as of 8/31/14 be worth $156,070.

Exchange Traded FundTicker
iShares Core S&P Mid-CapIJH$143.580.14%11.00%Mid-cap blend ETF
iShares NASDAQ Biotechnology IndexIBB$273.350.48%15.29%Trades like the NASDAQ biotech index ETF
PowerShares QQQQQQ$99.990.20%12.22%Large growth ETF
SPDR S&P MidCap 400MDY$261.590.25%10.78%Mid-cap blend ETF
Vanguard Small-Cap Index Fund ETF SharesVB$116.710.09%10.99%Small blend ETF

The second approach uses equal investments in selected ETFs for repeated bounces in their stock prices. One buys a certain amount of an ETF and then picks a review interval, for instance weekly or monthly, and when the asset in question has gone down more than 5% since the last transaction, the investor buys more, continuing in this way, whether once, ten times, or whatever, till the ETF has gone up by more than 5% above the initial purchase price, at which point all shares of that asset are sold. In the interim, one just waits till the next time the asset is down over 5% from the last transaction price, buys it again, etc.

The greater the frequency of the security's swings, the better, so long as there is reason for confidence that it will sooner or later, preferably sooner, be up enough to be sold once again. In most cases, there can be more confidence of this sort with exchange traded funds than is true for individual stocks (for which bad news can be ruinous). With the ETFs cited above, this strategy seems likely to be especially efficacious for IJH and QQQ, since they have tended to trade up and down multiple times in a year. With QQQ, for instance, there is often a quarterly drop after the asset is ex-dividend. Then the price rises more than 5% before the next such regular drop. (While that happy pattern has been true for awhile, there is no guarantee it will persist in future.)

If one gets an average net 5% gain four times a year, that works out to about a 21% return, not counting any dividends. More so than not, though, when an asset's price is noticed to be up enough to sell, it averages a little higher than the over 5% minimum for a sale. If that average net gain per round trip (a buy followed by a sale of the same shares) is, say, 7%, and occurs four or more times a year, the annualized performance works out to over 31%.

This is potentially the riskiest of the three approaches considered here, however, for one can never tell in advance how long the asset may go down before it heads back up enough to sell. Thus, it is helpful to keep one's investment amounts relatively low and one's initial cash reserves high. Later, once profitable sales have increased cash reserves further, it is possible to more safely raise per investment amounts.

Another way to be a somewhat active trader, yet with a cushion of safety, is to start with one-third of investment dollars in a money market account and initially just invest two-thirds in the five ETFs, again with a roughly equal amount spent for shares of each. Then, when there are monthly reviews of the portfolio and as market forces have taken each ETF up or down by significantly more than 5% (and beyond a threshold level that one determines for oneself to be the minimum per transaction amount), one sells or buys shares to maintain a core market value within 5% higher or lower than one's per ETF target.

This method tends to increase the number of shares of each ETF used and to lower the average cost per share. Shares sold off when the core holdings are higher than the 5% over threshold are being redeemed at a profit, their proceeds then being added to the money market account holdings, while shares bought when the core holdings are significantly below the 5% under threshold are clearly being obtained at a lower price. The system assures that one buys low and sells high. One is gaining not simply through the assets themselves gradually going higher in price, as is the case with the first, or buy-and-hold, approach, but also through capitalizing on the volatility of the individual assets selected for one's ETF portfolio.

For a handy reference to this latter technique's ins and outs, I can recommend the book How To Make $1,000,000 in the Stock Market Automatically! by Robert Lichello. Despite the obvious hype in that title and though the book was written when there were few if any financial instruments like exchange traded funds, this is a fun, useful little guide with practical applications to ETF investing.

In a later edition, Lichello revised and updated his system, recommending changing the initial money market allocation from half to one-third, with the equity portion thus being increased to two-thirds. This improved overall returns, though there was a greater chance that in significant bear markets one would exhaust available funds before all the automatic buying opportunities had been utilized. One remedy for this might be to review the portfolio and rebalance less often, perhaps quarterly instead of monthly.

Since profitable short-term trading has tax consequences, the cited trading approaches are most appropriate for IRAs or 401k investments.

Good luck with your own exchange traded fund researches, techniques development, and investing returns!


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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