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An Easy Way To Insure Against A Big Loss With Your ETFs

An allocation across a diversified mix of assets is always the best plan

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One of the more noticeable trends in the current U.S. stock bull has been the flip-flopping of the bears. Steven Russolillo at recently profiled a variety of prominent voices who received accolades in the past for extreme pessimism. Yet, even as price gains started to pile up in 2009, 2010, 2011, 2012, these folks insisted that the moves higher would not last. Eventually, each relented; each changed course by professing bullish optimism on U.S. equities. And names that had once been uttered with reverence – Roubini, Rosenberg, Parker, Whitney, Russell, Hendry — are now being snickered at.

Believe it or not, there are a few permanently bearish prognosticators that refuse to board the ridiculously crowded bull boat. One of the biggest personalities still firmly in the bear camp? John Hussman. The manager of Hussman Strategic Growth (HSGFX) rose to legendary status by avoiding the bulk of the bearish downturns in 2000-2002 as well as 2007-2009, racking up 7.7% annualized returns in the previous decade; the S&P 500 SPDR Trust (SPY) offered -0.8%. Unfortunately for Dr. Hussman, looking at the current 10-year period leaves HSGFX with a negative 10-year annualized return (-1.2%) and SPY with the impressive showing (7.0%).

Each of the names listed above were lauded as heroes for having predicted the financial collapse in 2008. By the same token, none of them predicted the enormous impact that unconventional central bank policy had on corporate profits, debt refinancing and market prices.

Bull market admirers are equally suspect. Ken Fisher, Jim Cramer and many of the members of the Federal Reserve did not call the 2008 credit crisis. Harry Dent, Henry Blodget and Ralph Acampora not only missed the 2000-2002 dot-com blow-up, they all pushed for different valuations for the transformative “New Economy.”

The lesson learned here is straightforward. There is simply no benefit to the investor for blindly following another’s absolute bullishness nor bearishness. If you fail to minimize monstrous downside slides, the financial and emotional periods over time can be devastating. The NASDAQ has not recovered its highs from 14 years ago. By the same token, if you wait to participate in market-based price appreciation based on rational or irrational reasons, you’re likely to spend years wondering went wrong as you sat on the sidelines.

Since market direction cannot be predicted, the media tend to push buy-n-hold laziness. The financial media get paid by financial companies with a vested interest in buying-n-holding.

However, the idea that one should ignore the NASDAQ dropping by 80% is ludicrous; the notion that an investor should sit on the SPDR S&P 500 Trust alone, regardless of 50% declines that require 100%-plus recoveries to break even is equally insane, as it ignores principles of insuring against disaster.

Investing successfully requires insurance. Stop-limit orders, trendline crosses, put options, inversely correlated hedges — reducing the pain in bad times is critical to insuring the preservation of capital and the protection of substantial price appreciation. What’s more, you do not have to predict the future to decide that you should pay a small premium to protect against experiencing monster losses. In fact, you do not even need to use a sophisticated method for insuring long-term results.

Below I have listed nine of the most popular ETFs by assets. Theoretically, one could allocate all of his/her dollars to these ETFs, constructing a diversified portfolio over several asset classes. On the other hand, a risk-conscious investor who values insuring his/her success would only allocate to those exchange-traded vehicles where the current price is above a long-term trendline like the 200-day moving average.

Nine of the Most Popular ETFs Traded On U.S. Exchanges
Above/Below 200-Day
SPDR S&P 500 Trust (SPY) Above
iShares MSCI EAFE (EFA) Above
Vanguard Emerging Markets (VWO) Below
iShares Russell 2000 (IWM) Above
Vanguard REIT (VNQ) Above
iShares Total U.S. Bond (AGG) Above
iShares High Yield Bond (HYG) Above
SPDR Gold Trust (GLD) Above
iShares TIPS Bond (TIP) Above

At the present moment, it is a good time for investors to be diversified across domestic stocks, foreign developed stocks, bonds and precious metals. The only asset that has struggled so intensely that it has not been able to hold above a long-term trendline is Vanguard Emerging Markets (VWO). Naturally, when an asset class is not doing well, media personalities (myself included) may wax philosophic about the reasons.

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