Tag Archives: opinion

How To Build A Portfolio With Less Risk Than The S&P 500

Summary When measuring risk adjusted returns over a long time period, SPY regularly beats individual investors. Due to high liquidity and small spreads, SPY is a better investment for investors that don’t want to worry constantly. For investors seeking more thorough diversification, I’ll lay out my portfolio plans. The long term bear case for SPY is a doomsday scenario, short term cases are arguments for market timing. Investors dealing with practical constraints such as trading costs have extremely low chances of beating SPY for risk adjusted returns. Every investor wants to be able to beat the market, but success is difficult to judge. Posting larger gains than the market by taking on additional risk is not the same thing as outperforming the market. I believe investors can occasionally struggle to see the forest because they are so caught up in the trees. Without stepping back, it may be difficult to judge how much risk is actually involved in any given portfolio. I think if we compare portfolios over a very long time period, many investors could agree that the deviation of returns is a viable metric for assessing risk. Under CAPM (Capital Asset Pricing Model), investors use Beta to establish the level of risk. I like that method, but it still has some substantial short comings. The theory assumes that every investor is holding the market portfolio and that diversification is in full effect. That causes some problems when we start assessing the required return. If the investor is not actually fully diversified, then the portfolio contains risks that could have been mitigated by better diversification. Making SPY the cornerstone Most textbooks will say that the S&P 500 is a viable proxy for “the market”. Since the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) is heavily focused on large cap U.S. equity, I don’t think that SPY should be seen as a proxy for every investment security. However, I do believe that SPY (or a similar ETF) should be the corner stone of most portfolios. Why SPY makes sense Even though SPY does not represent the entire market, it does represent the largest parts of the U.S. economy and many of the companies have global operations. If an investor wants to rapidly gain diversification to the market, SPY is the best place to start. The advantage of companies with global operations is that the ETF contains some of the diversification benefits of being exposed to foreign economies. Liquidity and spreads SPY offers investors extremely high levels of liquidity which lead to small spreads and a relatively easy time entering or exiting positions as necessary. On a risk adjusted basis When we adjusted for the level of risk, as measured by the deviation of returns, we find that SPY has a lower level of volatility than most ETFs. There are some ETFs with less deviation, but most of those ETFs have several of the same companies. If an ETF holds several of the same companies as SPY and posts high correlation, similar total returns, and similar levels of risk, then that ETF is a viable alternative to SPY. I’m perfectly fine with using alternatives to SPY, but I wouldn’t want to build a portfolio that did not use either SPY or one of the many similar ETFs. My strategy for building a portfolio I’m in the process of building a new retirement portfolio. The account will be tax advantaged. The difficulty for investors in opening a new account is that the balances will be relatively low. Because the balances are relatively low, trading fees are a significant detriment to the success of the account. Even if an investor has a substantial amount of money outside of the account, it won’t make a difference for the individual account. Since the new account has less capital and thus is more susceptible to trading fees, the appeal of using ETFs is even more substantial. My ideal ETF portfolio looks something like this: 30 to 50% to large cap companies (possibly split between 2 ETFs) 15% to 25% in bonds (part international, part domestic) 10% to 20% in international ETFs (probably using at least 2) 5% to 15% between precious metals and natural resource companies 10% to 20% to REITs Some ETFs that I think merit automatic consideration for those slots are listed below. In my opinion, these are some of the first ETFs investors should consider when seeking the exposures listed above. Large Cap: The Schwab U.S. Large-Cap ETF (NYSEARCA: SCHX ), the iShares Core S&P 500 ETF (NYSEARCA: IVV ) and the Vanguard S&P 500 ETF (NYSEARCA: VOO ) Bonds-International: The iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEARCA: EMB ) and the PowerShares Emerging Markets Sovereign Debt Portfolio ETF (NYSEARCA: PCY ) Bonds-Domestic: The Vanguard Total Bond Market ETF (NYSEARCA: BND ), the iShares Core Total U.S. Bond Market ETF (NYSEARCA: AGG ), the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ), the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ), the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA: LQD ) and the iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) -Note: PFF uses preferred stock International ETFs: The Vanguard FTSE Developed Markets ETF (NYSEARCA: VEA ), the iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ), the Schwab Emerging Markets ETF (NYSEARCA: SCHE ) and the iShares MSCI EAFE ETF (NYSEARCA: EFA ) Precious Metals: The SPDR Gold Trust ETF (NYSEARCA: GLD ), the iShares Gold Trust ETF (NYSEARCA: IAU ) and the iShares Silver Trust ETF (NYSEARCA: SLV ) Natural Resources: The Market Vectors Gold Miners ETF (NYSEARCA: GDX ), the FlexShares Morningstar Global Upstream Natural Resources Index ETF (NYSEARCA: GUNR ), the Energy Select Sector SPDR ETF (NYSEARCA: XLE ) and the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA: XOP ) REITs: The Schwab U.S. REIT ETF (NYSEARCA: SCHH ), the iShares U.S. Real Estate ETF (NYSEARCA: IYR ) and the Vanguard REIT Index ETF (NYSEARCA: VNQ ) As you can see from my desired exposures, the largest position by far will be substantially represented by SPY or a similar ETF. The position in natural resource companies will also duplicate some of the same stocks that I will be holding through the U.S. large cap ETF. For investors seeking to reduce risk below the levels created by SPY, the most likely way to do it still involves a fairly substantial position in either SPY or another similar fund. The strategy relies on using relatively low levels of correlation in the other investments. If the positions are relatively small, their correlation is more important than their individual volatility. Rather than building from the ground up, investors should be looking for incremental ways to reduce risk. Small positions in other ETFs have the opportunity to provide that incremental benefit. Rebalancing I will probably rebalance on a quarterly basis, but I might consider doing it as frequently as monthly. The portfolio I’ve laid out above suggests that I would probably be using at least 9 ETFs in my portfolio. The top four positions in the list would each be represented by two ETFs. The REIT position might be through a single ETF, depending on what I can find. First looks When I run my first inspection on an ETF as a candidate, I usually compare the standard deviation on daily returns to SPY. That gives me a quick estimation of the correlation between the two ETFs. If an ETF is not liquid and no shares trade hands on days when SPY jumps up or down as investors are scared to leave their positions, that is an unappealing aspect. Therefore, I also want to know about the volume of the shares being traded. Don’t be fooled into thinking that an average trading volume of 10,000 shares implies that there is enough liquidity for statistics to be valid. I’ve seen ETFs with reasonable average trading volumes post days with 0 shares changing hands. If no shares trade hands, it results in invalid statistics. If investors resume trading the following day at a significantly higher or lower price, it may understate the correlation by assessing the price movement to the wrong day. Yield One of the things I love about SPY is the distribution yield, currently 1.87%. One of my goals in planning for retirement is to get to the point where I can live off the dividends. Yes, I could use investments with substantially higher yields, but that often means additional risks. In my portfolio, I may be able to structure it to have a higher yield, but it won’t be a major factor since the money is all staying in the retirement account. Rich Dad, Poor Dad I believe every investor should read through Rich Dad, Poor Dad. It’s a fairly simple book and contains a great deal of common sense, but I still meet people every day that don’t understand the difference between assets and liabilities in their personal life. The most basic definition is that an asset should put money into your pocket. A liability would remove money from your pocket. The problem with buying into companies (or ETFs) with no dividend yield is that they are not directly putting money into your pocket. Selling shares to create your own dividends Every finance book dealing with economics will mention that investors have the option to sell their stocks and create their own dividend when they need the money. While that is true at a technical level, it ignores behavior finance. Investors are tempted to buy when the market is high and sell when it is low. If the investor can live off the dividends, they can avoid trading mistakes. Security SPY offers investors so much diversification through international exposure, that betting on SPY going down over a very long period is betting on the world falling apart. While individual companies can and do fall from grace (remember Enron), the system behind SPY is strong enough that investors have a very reasonable case to ignore the market and just keep dollar cost averaging into their positions. Market timing is absurdly difficult Attempting to time the market is a losing game. Yes, there are periods where the market crashes. That’s why I believe in adding a few other positions to the core position in the S&P 500. I love diversification, but I don’t see a viable argument against holding SPY over the long term. If the companies comprising the S&P 500 get crushed, what investment is truly safe? I don’t believe gold or the USD will hold substantial value in a hypothetical scenario where the S&P 500 gets destroyed. If Exxon Mobile (NYSE: XOM ) and Chevron (NYSE: CVX ) are both getting destroyed, how would you get to the store for groceries? If Wal-Mart (NYSE: WMT ) is getting crushed, what retail stores are surviving? In a doomsday scenario, I don’t see many investments holding their value. How I plan to handle it When I’m able to transfer money into the account, I won’t try to time my entry into positions. Money goes in, assets get purchased. That doesn’t mean I’m willing to cross a huge spread, but that isn’t a concern with SPY. Even though I have a desired outline for my portfolio, the only position that’s really secure is that I’ll use either SPY or another ETF with very similar exposures. The point of adding other ETFs is that they provide benefits to the core position. If I can’t find enough ETFs that provide complimentary positions to SPY, I’ll just reallocate that position to even more S&P 500. Using SPY to avoid commissions If I didn’t have access to trading many ETFs without commissions, I wouldn’t expect the benefits of further diversification to outweigh the trading costs. If I hold 9 ETFs and rebalance quarterly, I’m looking at 36 trades per year. Assuming $10 per trade, we are talking about $360 per year. In a new retirement account with a starting balance of around $10,000, that’s a huge chunk. The difference between $40 and $360 over the course of the year is comparing .4% to 3.6% in expenses. Beating SPY in risk adjusted returns through active selection is very difficult. If an investor has to beat another 3.2% to cover the trading fees, it becomes nearly impossible. Remember, returns must recognize risk, so buying a single security that does very well is still taking on an enormous amount of risk. If I was paying commissions If I learned tomorrow that I would not be able to trade without commissions, I would make one trade upon getting the money into my retirement account. I would run a portfolio that was at least 80% SPY. Until I had over $50,000 in the account, I wouldn’t even consider reducing the SPY position. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.

MDYG Looks Like A Great ETF, I Don’t See A Single Weakness

Summary I’m taking a look at MDYG as a candidate for inclusion in my ETF portfolio. MDYG offers investors enough liquidity to reduce risks of being stuck in an undesired position. The liquidity, in my opinion, is better than it appears from trading volume. The correlation is respectable and based off a strong enough level of liquidity that I have some confidence in the statistics. From the diversification to the expense ratio, I can’t find a single problem. I don’t intend to focus on “growth” companies, but I might make a small niche for MDYG. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. How to read this article : If you’re new to my ETF articles, just keep reading. If you have read this intro to my ETF articles before, skip down to the line of asterisks. This section introduces my methodology. By describing my method initially, investors can rapidly process each ETF analysis to gather the most relevant information in a matter of minutes. My goal is to provide investors with immediate access to the data that I feel is most useful in making an investment decision. Some of the information I provide is readily available elsewhere, and some requires running significant analysis that, to my knowledge, is not available for free anywhere else on the internet. My conclusions are also not available anywhere else. What I believe investors should know My analysis relies heavily on Modern Portfolio Theory. Therefore, I will be focused on the statistical implications of including a fund in a portfolio. Since the potential combinations within a portfolio are practically infinite, I begin by eliminating ETFs that appear to be weak relative to the other options. It would be ideal to be able to run simulations across literally billions of combinations, but it is completely impractical. To find ETFs that are worth further consideration I start with statistical analysis. Rather than put readers to sleep, I’ll present the data in charts that only take seconds to process. I include an ANOVA table for readers that want the deeper statistical analysis, but readers that are not able to read the ANOVA table will still be able to understand my entire analysis. I believe there are two methods for investing. Either you should know more than the other people performing analysis so you can make better decisions, or use extensive diversification and math to outperform most investors. Under CAPM (Capital Asset Pricing Model), it is assumed every investor would hold the same optimal portfolio and combine it with the risk free asset to reach their preferred spot on the risk and return curve. Do you know anyone that is holding the exact same portfolio you are? I don’t know of anyone else with exactly my exposure, though I do believe there are some investors that are holding nothing but SPY. In general, I believe most investors hold a portfolio that has dramatically more risk than required to reach their expected (under economics, disregarding their personal expectations) level of returns. In my opinion, every rational investor should be seeking the optimal combination of risk and reward. For any given level of expected reward, there is no economically justifiable reason to take on more risk than is required. However, risk and return can be difficult to explain. Defining “Risk” I believe the best ways to define risk come from statistics. I want to know the standard deviation of the returns on a portfolio. Those returns could be measured daily, weekly, monthly, or annually. Due to limited sample sizes because some of the ETFs are relatively new, I usually begin by using the daily standard deviation. If the ETF performs well enough to stay on my list, the next levels of analysis will become more complex. Ultimately, we probably shouldn’t be concerned about volatility in our portfolio value if the value always bounced back the following day. However, I believe that the vast majority of the time the movement today tells us nothing about the movement tomorrow. While returns don’t dictate future returns, volatility over the previous couple years is a good indicator of volatility in the future unless there is a fundamental change in the market. Defining “Returns” I see return as the increase over time in the value known as “dividend adjusted close”. This value is provided by Yahoo. I won’t focus much on historical returns because I think they are largely useless. I care about the volatility of the returns, but not the actual returns. Predicting returns for a future period by looking at the previous period is akin to placing a poker bet based on the cards you held in the previous round. Defining “Risk Adjusted Returns” Based on my definitions of risk and return, my goal is to maximize returns relative to the amount of risk I experienced. It is easiest to explain with an example: Assume the risk free rate is 2%. Assume SPY is the default portfolio. Then the risk level on SPY is equal to one “unit” of risk. If SPY returns 6%, then the return was 4% for one unit of risk. If a portfolio has 50% of the risk level on SPY and returns 4%, then the portfolios generated 2% in returns for half of one unit of risk. Those two portfolios would be equal in providing risk adjusted returns. Most investors are fueled by greed and focused very heavily on generating returns without sufficient respect for the level of risk. I don’t want to compete directly in that game, so I focus on reducing the risk. If I can eliminate a substantial portion of the risk, then my returns on a risk adjusted basis should be substantially better. Belief about yields I believe a portfolio with a stronger yield is superior to one with a weaker yield if the expected total return and risk is the same. I like strong yields on portfolios because it protects investors from human error. One of the greatest risks to an otherwise intelligent investor is being caught up in the mood of the market and selling low or buying high. When an investor has to manually manage their portfolio, they are putting themselves in the dangerous situation of responding to sensationalistic stories. I believe this is especially true for retiring investors that need money to live on. By having a strong yield on the portfolio it is possible for investors to live off the income as needed without selling any security. This makes it much easier to stick to an intelligently designed plan rather than allowing emotions to dictate poor choices. In the recent crash, investors that sold at the bottom suffered dramatic losses and missed out on substantial gains. Investors that were simply taking the yield on their portfolio were just fine. Investors with automatic rebalancing and an intelligent asset allocation plan were in place to make some attractive gains. Personal situation I have a few retirement accounts already, but I decided to open a new solo 401K so I could put more of my earnings into tax advantaged accounts. After some research, I selected Charles Schwab as my brokerage on the recommendation of another analyst. Under the Schwab plan “ETF OneSource” I am able to trade qualifying ETFs with no commissions. I want to rebalance my portfolio frequently, so I have a strong preference for ETFs that qualify for this plan. Schwab is not providing me with any compensation in any manner for my articles. I have absolutely no other relationship with the brokerage firm. Because this is a new retirement account, I will probably begin with a balance between $9,000 and $11,000. I intend to invest very heavily in ETFs. My other accounts are with different brokerages and invested in different funds. Views on expense ratios Some analysts are heavily opposed to focusing on expense ratios. I don’t think investors should make decisions simply on the expense ratio, but the economic research I have covered supports the premise that overall higher expense ratios within a given category do not result in higher returns and may correlate to lower returns. The required level of statistical proof is fairly significant to determine if the higher ratios are actually causing lower returns. I believe the underlying assets, and thus Net Asset Value, should drive the price of the ETF. However, attempting to predict the price movements of every stock within an ETF would be a very difficult and time consuming job. By the time we want to compare several ETFs, one full time analyst would be unable to adequately cover every company. On the other hand, the expense ratio is the only thing I believe investors can truly be certain of prior to buying the ETF. Taxes I am not a CPA or CFP. I will not be assessing tax impacts. Investors needing help with tax considerations should consult a qualified professional that can assist them with their individual situation. The rest of this article By disclosing my views and process at the top of the article, I will be able to rapidly present data, analysis, and my opinion without having to explain the rationale behind how I reached each decision. The rest of the report begins below: ******** (NYSEARCA: MDYG ): SPDR® S&P 400 Mid Cap Growth ETF Tracking Index: S&P MidCap 400 Growth Index Allocation of Assets: At least 80% to securities in the index Morningstar® Category: Mid-Cap growth Time period starts: April 2012 Time period ends: December 2014 Portfolio Std. Deviation Chart: (click to enlarge) (click to enlarge) Correlation: 85.22% Returns over the sample period: (click to enlarge) Liquidity (Average shares/day over last 10): About 17,000 Days with no change in dividend adjusted close: 10 Days with no change in dividend adjusted close for SPY: 5 Yield: .88% Distribution Yield Expense Ratio: .25% Discount or Premium to NAV: .16% premium Holdings: (click to enlarge) Further Consideration: Definitely Conclusion: MDYG comes out of this looking fairly reasonable. It isn’t my goal to put a growth weighting into my portfolio, but the correlation is respectable, the liquidity is solid, and the expense ratio is reasonable. While liquidity of 17,000 isn’t huge, the dividend adjusted close was regularly changing. Out of the 10 days in which the dividend adjusted close did not change, there were 5 in which the trading volume was actually 0 for the day. In my opinion, that’s enough liquidity to be worthy of consideration. The yield isn’t very high, but I can deal with that. If I wanted to orient my portfolio towards growth rather than value I think MDYG would be a very strong contender. Due to the orientation I want, if I use MDYG it will be a fairly small position and I will have to compare it directly with a few other ETFs that focus on growth. For my investing style, the ideal exposure is probably around 5%. The best thing for the ETF is probably the complete lack of red flags that I’ve seen. There is no single factor that I can point out as a problem. In my opinion, any ETF that comes out of this with 0 intrinsic weaknesses deserves some consideration. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.

Be Knowledgeable About Liquidity, Don’t Get Fooled By KNOW

Summary I’m taking a look at KNOW as a candidate for inclusion in my ETF portfolio. The average volume looks high enough that the low correlation would seem reliable. Checking the historical data on volume shows that there were a striking number of days with no trades recorded. Despite the interesting concept and strong returns so far, I’m not fond of a very high expense ratio being combined with an ETF that frequently sees a volume of 0. I’m not assessing any tax impacts. Investors should check their own situation for tax exposure. How to read this article : If you’re new to my ETF articles, just keep reading. If you have read this intro to my ETF articles before, skip down to the line of asterisks. This section introduces my methodology. By describing my method initially, investors can rapidly process each ETF analysis to gather the most relevant information in a matter of minutes. My goal is to provide investors with immediate access to the data that I feel is most useful in making an investment decision. Some of the information I provide is readily available elsewhere, and some requires running significant analysis that, to my knowledge, is not available for free anywhere else on the internet. My conclusions are also not available anywhere else. What I believe investors should know My analysis relies heavily on Modern Portfolio Theory. Therefore, I will be focused on the statistical implications of including a fund in a portfolio. Since the potential combinations within a portfolio are practically infinite, I begin by eliminating ETFs that appear to be weak relative to the other options. It would be ideal to be able to run simulations across literally billions of combinations, but it is completely impractical. To find ETFs that are worth further consideration I start with statistical analysis. Rather than put readers to sleep, I’ll present the data in charts that only take seconds to process. I include an ANOVA table for readers that want the deeper statistical analysis, but readers that are not able to read the ANOVA table will still be able to understand my entire analysis. I believe there are two methods for investing. Either you should know more than the other people performing analysis so you can make better decisions, or use extensive diversification and math to outperform most investors. Under CAPM (Capital Asset Pricing Model), it is assumed every investor would hold the same optimal portfolio and combine it with the risk free asset to reach their preferred spot on the risk and return curve. Do you know anyone that is holding the exact same portfolio you are? I don’t know of anyone else with exactly my exposure, though I do believe there are some investors that are holding nothing but SPY. In general, I believe most investors hold a portfolio that has dramatically more risk than required to reach their expected (under economics, disregarding their personal expectations) level of returns. In my opinion, every rational investor should be seeking the optimal combination of risk and reward. For any given level of expected reward, there is no economically justifiable reason to take on more risk than is required. However, risk and return can be difficult to explain. Defining “Risk” I believe the best ways to define risk come from statistics. I want to know the standard deviation of the returns on a portfolio. Those returns could be measured daily, weekly, monthly, or annually. Due to limited sample sizes because some of the ETFs are relatively new, I usually begin by using the daily standard deviation. If the ETF performs well enough to stay on my list, the next levels of analysis will become more complex. Ultimately, we probably shouldn’t be concerned about volatility in our portfolio value if the value always bounced back the following day. However, I believe that the vast majority of the time the movement today tells us nothing about the movement tomorrow. While returns don’t dictate future returns, volatility over the previous couple years is a good indicator of volatility in the future unless there is a fundamental change in the market. Defining “Returns” I see return as the increase over time in the value known as “dividend adjusted close”. This value is provided by Yahoo. I won’t focus much on historical returns because I think they are largely useless. I care about the volatility of the returns, but not the actual returns. Predicting returns for a future period by looking at the previous period is akin to placing a poker bet based on the cards you held in the previous round. Defining “Risk Adjusted Returns” Based on my definitions of risk and return, my goal is to maximize returns relative to the amount of risk I experienced. It is easiest to explain with an example: Assume the risk free rate is 2%. Assume SPY is the default portfolio. Then the risk level on SPY is equal to one “unit” of risk. If SPY returns 6%, then the return was 4% for one unit of risk. If a portfolio has 50% of the risk level on SPY and returns 4%, then the portfolios generated 2% in returns for half of one unit of risk. Those two portfolios would be equal in providing risk adjusted returns. Most investors are fueled by greed and focused very heavily on generating returns without sufficient respect for the level of risk. I don’t want to compete directly in that game, so I focus on reducing the risk. If I can eliminate a substantial portion of the risk, then my returns on a risk adjusted basis should be substantially better. Belief about yields I believe a portfolio with a stronger yield is superior to one with a weaker yield if the expected total return and risk is the same. I like strong yields on portfolios because it protects investors from human error. One of the greatest risks to an otherwise intelligent investor is being caught up in the mood of the market and selling low or buying high. When an investor has to manually manage their portfolio, they are putting themselves in the dangerous situation of responding to sensationalistic stories. I believe this is especially true for retiring investors that need money to live on. By having a strong yield on the portfolio it is possible for investors to live off the income as needed without selling any security. This makes it much easier to stick to an intelligently designed plan rather than allowing emotions to dictate poor choices. In the recent crash, investors that sold at the bottom suffered dramatic losses and missed out on substantial gains. Investors that were simply taking the yield on their portfolio were just fine. Investors with automatic rebalancing and an intelligent asset allocation plan were in place to make some attractive gains. Personal situation I have a few retirement accounts already, but I decided to open a new solo 401K so I could put more of my earnings into tax advantaged accounts. After some research, I selected Charles Schwab as my brokerage on the recommendation of another analyst. Under the Schwab plan “ETF OneSource” I am able to trade qualifying ETFs with no commissions. I want to rebalance my portfolio frequently, so I have a strong preference for ETFs that qualify for this plan. Schwab is not providing me with any compensation in any manner for my articles. I have absolutely no other relationship with the brokerage firm. Because this is a new retirement account, I will probably begin with a balance between $9,000 and $11,000. I intend to invest very heavily in ETFs. My other accounts are with different brokerages and invested in different funds. Views on expense ratios Some analysts are heavily opposed to focusing on expense ratios. I don’t think investors should make decisions simply on the expense ratio, but the economic research I have covered supports the premise that overall higher expense ratios within a given category do not result in higher returns and may correlate to lower returns. The required level of statistical proof is fairly significant to determine if the higher ratios are actually causing lower returns. I believe the underlying assets, and thus Net Asset Value, should drive the price of the ETF. However, attempting to predict the price movements of every stock within an ETF would be a very difficult and time consuming job. By the time we want to compare several ETFs, one full time analyst would be unable to adequately cover every company. On the other hand, the expense ratio is the only thing I believe investors can truly be certain of prior to buying the ETF. Taxes I am not a CPA or CFP. I will not be assessing tax impacts. Investors needing help with tax considerations should consult a qualified professional that can assist them with their individual situation. The rest of this article By disclosing my views and process at the top of the article, I will be able to rapidly present data, analysis, and my opinion without having to explain the rationale behind how I reached each decision. The rest of the report begins below: ******** (NYSEARCA: KNOW ): Direxion All Cap Insider Sentiment Shares Tracking Index: Sabrient Multi-Cap Insider/Analyst Quant-Weighted Index Allocation of Assets: At least 80% within the index Morningstar® Category: Mid-Cap Blend Time period starts: April 2012 Time period ends: December 2014 Portfolio Std. Deviation Chart: (click to enlarge) (click to enlarge) Correlation: 62.75% Returns over the sample period: (click to enlarge) Liquidity (Average shares/day over last 10): About 10,000 Days with no change in dividend adjusted close: 180 Days with no change in dividend adjusted close for SPY: 5 Yield: 1.13% Distribution Yield Expense Ratio: Gross 1.69% and Net 0.65% Discount or Premium to NAV: 0.06% premium Holdings: (click to enlarge) Further Consideration: Yes Conclusion: KNOW is a very interesting and aptly named ETF. The ETF is investing by tracking movements by insiders. It is an interesting strategy and an ETF that automates the strategy may provide much lower costs than an investor attempting to use the strategy by themselves. While I’m not convinced that the strategy works any better than holding SPY, I find the idea of doing it through an ETF novel so I will keep it on the list. If there is actually a lower correlation because of movements in the positions it could be a useful ETF under modern portfolio theory. However, despite an average trading volume of over 10,000 shares, there were 180 days with no change in the dividend adjusted close. I thought that was strange so I ran a volume test over the period checking for days in which 0 shares were traded. There were 174 days in which that happened. That reinforces the theory that despite decent trading volumes in the average over the last 10 days, the calculated correlation has been dramatically altered by liquidity that is much worse than it would have seemed at first glance. In this case I would advise investors to be very wary of relying on the average volume as a sole indicator of liquidity. The distribution yield may be subject to change as the holdings of the ETF change, so I wouldn’t recommend this for anyone needing a consistent yield out of their portfolio. As any of my frequent readers know, I won’t be a fan of the expense ratio. I recognize that the ETF may have significantly more trading costs to cover because of their strategy, but I don’t like seeing values that are so high. The net expense ratio is substantially below the gross expense ratio because of waivers and reimbursement policies in place through September 1st, 2015. I can deal with poor liquidity in the sense of weak average volume, but the frequency of a recorded volume of 0 combined with the expense ratios make it unlikely that KNOW will survive the next round of cuts, even though I’m putting it through to the second round for now. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.