Archive for February, 2010

Free ETF trading

Several brokers are offering ETF (Exchange Traded Funds) trading for free. This is a significant change in strategy for ETF providers which may change the investment landscape. However, for this newsletter, we will concentrate on how it impacts you. Because trading costs can have a significant impact on long term investment performance, a free offer should merit serious consideration.

The first question to ask is: why is something being offered for free?

That is always a good first question and the answer is almost always, it’s not free. Like free to air television, someone is picking up the tab. In this case, the ETF providers are compensating the brokers (Fidelity and Schwab) to promote their products to retail investors.

Why are they doing this? Simple, they want to capture your stable retail assets.

The sponsors of ETFs are in the asset collection game not the investment performance game. The vast majority of ETFs are linked to an index or a commodity price. Their goal is to offer you exposure to a stated index or commodity price with the least amount of “tracking error” (the difference between the index price and the Net Asset Value of the ETF) possible.

ETFs are very popular with institutional investors, particularly with hedge funds and proprietary trading desks. In fact, one key feature of ETFs (low discounts/premia) is the ability of qualified institutional investors to deliver or receive the underlying basket of assets, creating or redeeming ETF shares at will. The fact that one can trade options, short and margin ETFs, like any other listed stock, makes them extremely attractive as the building blocks underneath many complex investment strategies.

But retail investors are still not as big a part of the pie as the large ETF providers would like. Why do they want you? Because having a stable base of shareholders provides a stable base of management fees to the ETF sponsor. Institutional investors provide deep liquidity and keep the ETF price in line but retail investors will provide the solid base of recurring income. The longer you hold an ETF, the longer the ETF provider gets to charge a management fee.

The second question is: Now you know why companies like iShares and Schwab are making this offer, should you take them up on it?

Here are three questions to help you decide if ETFs can be a part of your portfolio.

  1. Are you willing to manage the overall direction of your investment portfolio?
  2. Do you have enough money to participate?
    About $20,000 will allow you to buy enough round lots of 100 to get proper diversification.
  3. Do you have an online broker to provide low cost limit trades?
    $7-$10 a trade is the standard rate. But, because trading can be volatile, especially at the opening bell, you want to place limit orders to ensure a good execution near the NAV.

If you answer no to any of these three questions, you should probably stick with mutual funds for now. A no-load index fund will provide most of the benefits of an ETF and may be a better way to start exploring the benefits of low cost investment strategies.

If you answered yes to the three questions , we are building the resources you need. Check out our pages for Brokers and ETFs.

Why is investing so difficult?

After a fairly drab beginning to the investment year, we decided to explore a central issue which led to the development of the IRP System. The issue is the perception that investing is a difficult and complicated process.

Is investment a difficult and complicated process? Yes, but not for the reasons most people think.

Not a resource or knowledge gap.

Investors, both amateur and professional, are often intimidated by the vast amount of financial market data available for collection, organization and calculation. Financial professionals from the established firms, pundits from the news and financial media and various experts, gurus and assorted soothsayers on the internet (192m hits for the search term “investment”) certainly give the impression that the main obstacle to successful investment is access to the tools that will unlock the secrets of the market. For the most part, they also seem to speak a different language when they talk about what drives the market.

Vendors of financial products highlight the tremendous resources that they have invested to bring you good investment products. The unspoken point is that an amateur investor is hopelessly outclassed in this financial arms race.

While we recognize that the intense competition to out-analyze the next investor has led to large and efficient financial markets, we would argue that the real answer to why investment is difficult lies elsewhere.

We think investing is difficult for two reasons:


We have explored this issue in our e-book. Simply stated, the biggest obstacle to a successful investment plan is the Limbic system, the fight or flight portion of your brain that sits between the outer cortexes (where complex functions like thought and speech take place) and your brainstem (which controls involuntary functions like breathing and heartrate). The Limbic System secretes happy hormones when the markets are near their tops, boosting confidence in our buy decisions. And when markets fall, the chemistry lab in our Limbic System supplies us with just the right cocktail to help us sell at the bottom. Our emotions lead us to buy high and sell low. Any system which avoids that outcome is by definition superior to relying on “gut feelings.”

Attention to detail

This is another serious drag on any investment plan because the usual solution is to outsource the minutiae of the investment process at a very high price. There is nothing wrong with paying a reasonable management and custodian fee. But investors do not realize that there is often no value associated with high front end loads or large withdrawal penalties. These fees can have a significant impact on long term investment performance.

New initiative

While our main efforts have been on fine tuning the system to remove emotions from our investing , we are looking to close the gap on the details of investment which many find intimidating and often expensive.

We will concentrate on the products (primarily active and passive funds and ETFs) and the best ways to access those products online and in person.

Since many of our conclusions will be highly subjective, we welcome any input from our readers.

Shifting into lower gear

While most investors will concentrate on the poor performance of the financial markets in January (especially after such a strong first week), the important issue to focus on is the shift in institutional money out of Asia generally, and China specifically.

Where is the money going? If you look at the individual portfolios, it is a mix. It is not flying for the safety of gold or US Treasury bonds. We are seeing a rational re-evaluation of opportunities. Strength remains in Real Estate, Technology, Health Care, Emerging Europe, Latin America, and Precious Metals (with Silver still catching up to Gold). In Asia, that has translated into a preference for Indonesia (as a commodities supplier to emerging giants China and India) and Taiwan (a critical juncture in the Technology supply chain). Looking deeper into Taiwan, the subsectors that pop to the top of the list are Optoelectronics and Electronic Components, confirming that the relative buoyancy in Taiwan is due to the Tech Sector.

However, it should be noted that the signals are much more subdued than they were even three months ago, suggesting that investment returns will return to more “normal” rates in the coming months. That squares with the newsflow. The strong US GDP figure for the fourth quarter, which was largely driven by inventory replenishment, is a lagging indicator. All of the market reaction to that figure already happened in the second half of 2009. Unless there is a dramatic pickup in consumer demand, the next few GDP readings will be more like 1% or 2% growth.

So, what are we looking for in the coming months? Overall, we think the markets will be volatile on a daily and intra week basis but that the week to week or month to month overall performance will not be dramatic. We are not looking at another trip off the cliff like the one we saw in 2008 and the beginning of 2009. Nor are we looking for a fresh bull market from these levels. Rather, we think there will be a return to rotational interest as the excess reserves created by the world’s Central Bankers continue to slosh around the globe. There is no doubt that Central Bankers and their governments are looking for exit strategies and that the volume of their money pumping activities will drop year on year but the high powered money from last year will remain in the system. With unemployment high, governments will continue to concentrate on inflation measurements that exclude commodities so that interest rates can stay at low levels. This is important for stabilizing the banking system but excess liquidity will continue to leak out into financial markets. Politics (US elections in November) and the ghosts of 1937 will keep the FED from doing anything dramatic. The ECB is unlikely to do anything that will exacerbate the sovereign default risk or make the Euro appreciate.

For investors, we recommend that you check your portfolios on a weekly basis and check other portfolios for ideas.