5 Mistakes To Avoid With Your ETF Portfolio

As more and more investors adopt exchange-traded funds in their portfolios, it is becoming increasingly important to understand the opportunities and risks in these unique investment vehicles. The first step to success with trading ETFs is to avoid potential pitfalls, which is why I wanted to point out some of the common mistakes that I see made whenever I am reviewing investors’ portfolios.

1. Don’t Fall In Love With Your ETFs

Fall in love with your wife, your kids, even your pets. But do not make the cardinal sin of falling in love with your investments. I have often seen investors get so enamored with a specific theme, stock, or ETF in their portfolio that they throw out the rules of risk management and end up riding it from a big gain to a big loss. The damage to both your portfolio value and your confidence is one of the reasons that I always use a stop loss or other risk management discipline on every position in my portfolio.

One example of a theme that has fallen out of favor this year is precious metals. The MarketVectors Gold Miners ETF (GDX) as well as the iShares Silver Trust (SLV) have seen their value fall 49% and 38% respectively over the last 9 months. While these ETFs have had fantastic returns in prior years, they have been slowed by a rash of institutional selling and unfavorable economic conditions. Remember that a 50% decline requires a 100% gain to get back to break even. Don’t let these types of declines weigh on your performance like a boat anchor.

2. Be Mindful of Trading Volume and Liquidity

If you are buying or selling the SPDR S&P 500 ETF (SPY) which regularly trades over 150 million shares per day on average, then you don’t have to worry about trade execution. A simple market order will fill your order instantaneously within a penny of the current price. However, a more thinly traded ETF may have disastrous execution prices that can be a huge cost to your performance. An ETF with lower volume will usually have a larger spread between the bid and ask price, which will leave the door open for a market maker to take advantage of you.

As a general rule, I recommend that you look for ETFs that have average daily trading volume of at least 100,000 shares and that you use a limit order for larger positions so that you control your execution price. In addition, you should be cognizant of how liquid the underlying holdings of the ETF are, which may play a factor in the execution and daily pricing of your order as well.

3. Know What You Own and Why You Own It

Just because an investment has a 3 or 4 digit ticker symbol (and isn’t a stock) does not mean that it is an ETF. Remember that there are closed-end funds and exchange-traded notes that often times get mistaken for ETFs.

A closed-end fund has a defined number of shares and can trade at a large premium or discount to the net asset value of the underlying holdings based on investor demand. In addition, a closed-end fund manager may have the ability to use leverage, adjust holdings, and distribute capital at his discretion.

An exchange-traded note is an unsubordinated debt instrument that tracks the return of a specified index. They are backed by the credit worthiness of the bank that issues them instead of the underlying holdings of the fund. These ETNs often times replicate a sophisticated trading strategy or commodity index that is easier to access though this structure.

Be sure to closely research the structure of the fund that you are buying as well as the underlying holdings, expenses, track record, and tax ramifications. This early research can pay huge dividends in your portfolio down the road.

4. Not All ETFs are Created Equal

One of the hidden pitfalls of investing in certain commodity related ETFs is the tax ramifications of their legal structure. What I am referring to is the difference between an ETF that is structured as a trust that generates a 1099 vs. being structured as a partnership that generates a K-1. One of the largest ETFs in the commodity space that is structured as a partnership is the PowerShares DB Commodity Index Tracking Fund (DBC). This ETF tracks a diversified basket of commodities that include precious metals, oil, agriculture, and base metals.

First time investors in DBC, who haven’t done their homework, will be surprised when they receive a K-1 for partnership income that does not correlate to their dividends or capital gains. The reason for this is that the fund must be structured as a partnership in order to participate in buying commodity futures contracts. When you purchase DBC you are considered to be participating in the gains or losses of the partnership and thus receive a K-1 statement that must be dealt with on your tax return.

This additional tax burden may be a headache that individual investors can avoid by simply finding an alternative such as the iPath S&P GSCI Total Return ETN (GSP). The underlying index that GSP tracks is similar to DBC and you won’t receive a K-1 because it is structured as an exchange-traded note.

5. Don’t get Too Overweight In One Area

ETFs by nature are diversified investment vehicles, but often times I review portfolios that are very much overweight in one area such as precious metals, technology, or even cash. I always recommend that you consider using core positions such as the iShares MSCI Minimum Volatility ETF (USMV) or the Vanguard Total Stock Market ETF (VTI) as the building blocks for your asset allocation. Then layer in sectors such as the Healthcare Select Sector SPDR (XLV) or First Trust NASDAQ Technology Dividend Index (TDIV) to enhance your returns.

In addition, it’s important to balance your asset allocation across bonds, commodities, and international stocks by expanding and collapsing those sleeves when conditions are most favorable. This will ensure that you are staying diversified and taking a proactive approach to managing your portfolio.

Additional disclosure: David Fabian, Fabian Capital Management, and/or its clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.

By David Fabian

Source: http://seekingalpha.com/article/1509912-5-mistakes-to-avoid-with-your-etf-portfolio?source=email_etf_daily&ifp=0

An Even Easier Dividend Growth Portfolio

Nine letters that’s all it takes. No watching of companies. No need to concern yourself with what companies are missing on earnings, cutting their dividend, eliminating their dividend or freezing their dividend. Just punch in three numbers and rebalance with the income that the portfolio generates. Adding new monies on a regular basis is also the greatest favour you can do for yourself as well, of course.

Here’s an income producing portfolio that you can hold until and through retirement. Here are those nine letters.

(CVY) (VYM) (KXI)

Those nine letters will give you broad exposure to U.S. and international dividend payers and sectors such as REITs and MLPs with a sprinkling of some Canadian energy companies. It simplifies the multiple dividend growth ETF I put together that added REITs and MLPs in this articlehere.

At the core of the dividend growth ETF portfolios that I’ve been suggesting readers consider is Vanguard’s VYM. It’s a broad based “higher yielding” dividend growth ETF. It holds many or most of the U.S. based stalwarts that we see in the portfolios of dividend growth investors who write or comment on Seeking Alpha.

VYM – Top Holdings

Exxon Mobil (XOM), Microsoft (MSFT), General Electric (GE), Chevron (CVX), AT&T (T), Procter & Gamble (PG), Johnson & Johnson (JNJ), Wal-Mart (WMT), Pfizer (PFE), Coca-Cola (KO), Philip Morris (PM), Merck (MRK), Verizon Communications (VZ), PepsiCo (PEP), Intel (INTC), Abbott Laboratories (ABT), Home Depot (HD), McDonald’s (MCD), United Technologies (UTX), ConocoPhillips (COP), 3M (MMM), Altria Group (MO), Eli Lilly (LLY) Colgate-Palmolive (CL), Emerson Electric (EMR), Illinois Tool Works (ITW).

From there I would suggest that dividend growth investors add some international exposure with KXI, an ETF from iShares – a Global Consumer Staples ETF. This sector is prime breeding ground for dividend companies. There is certainly some overlap between the U.S. VYM and International holdings, but it does offer some broader international exposure. Investors can sometimes forget that the U.S. markets can underperform at times. Here’s how a combination of Canada (EWC) and the international index EAFE (EFA) outperformed the U.S. markets from January of 2003 through to the end of 2007. Adding some international exposure can pay off.

Here’s a list of some of the top holdings and their percentage of the global ETF KXI.

From there I would suggest some yield chasing with a multi asset class ETF from Guggenheim – CVY.

This from Guggenheim … The Fund, using a low cost “passive” or “indexing” investment approach, seeks to replicate, before fees and expenses, the performance of the Zacks Multi Asset Income Index. The Zacks Multi Asset Income Index is comprised of approximately 125 to 150 securities selected, based on investment and other criteria, from a universe of domestic and international companies. The universe of securities within the Index includes:

• U.S.-listed common stocks
• American depositary receipts (“ADRs”) paying dividends
• Real estate investment trusts (“REITs”)
• Master limited partnerships (“MLPs”)
• Closed-end funds
• Canadian royalty trusts
• Traditional preferred stocks

Here is the sector breakdown and the top ten holdings.

The fund offers a 12-month yield of 5.15%. While the yield took a hit in the financial crisis, the ETF has delivered some nice income growth from June of 2009. The dividends have increased from .22 cents a quarter to .32 cents a quarter representing a 9.82% dividend growth rate over that 4 year period. Though the income has now only returned to its 2006 levels.

I was enticed to look for a U.S. multi-asset class ETF as I use a similar product up here in the great white north. My multi-asset class ETF now offers a current yield of just under 7.4%. Interest rate worries have certainly hammered the interest rate sensitive high yield bonds, utilities and REITs that it holds. I am looking to add to this position within normal reinvestment of investment income. One of my main Canadian dividend growth ETFs also offers a yield of 5%. There is some decent value up here in Canada as our markets have lagged.

Of course CVY will also present its own risks in relation to interest rates and sector exposure.

So what happens when you put those nine letters together in a portfolio? Let’s have a look at some historical (but brief) returns. The portfolio is limited to November of 2006 – VYM’s inception date. The ETFs each get equal weighting of 33.3% each.

The Nine-Letter ETF portfolio total return was 49% from November 2006 to present, outperforming the S&P 500’s total return of 33.4%. That’s a significant outperform by 47%.

And what would have happened with this portfolio mix on the income front? As stated above CVY has some decent income growth over a 4-year period – a 9% compound average growth rate to go with that 5% plus yield. VYM offers an SEC yield listed at 3.15% and a dividend growth rate of 8.5%. KXI offers a current yield of 2.4% and a dividend growth rate of 11% over five years.

Put them together and here’s an estimate of dividend growth history. Calculating or estimating dividend growth rates of ETFs is not an exact science to be sure. I will take averages of a year or 2-3 quarterly dividend payment of an ETF to smooth out ETF dividend payments that can fluctuate with regularity.

ETF	Yield	Dividend Growth Rate
VYM	3.15%	8.5%
KXI	2.4%	11%
CVY	5.15%	9.8%
Portfolio Total	3.5%	9.8%

And yes, I have blended some time frames to make this projection. Again, the CVY growth rate is shorter term coming out of the recession and is calculated from the bottom of its income history. As the ETFs themselves do not offer 10 and 15 year histories, we are limited. That said, one can look at the underlying holdings of these ETFs and see long term histories of dividends and dividend growth.

This may be a simple three ETF portfolio, but it offers broad sector and international exposure. It has some nice numbers on total return and income generation.

For those who want to temper price volatility (that’s most everyone), they can balance the holdings with a bond ETF or two. If one wants the classic balanced portfolio they may consider holding 60% of the above ETFs combined with 40% from a broad based bond ETF such as (AGG). For those concerned with rising interest rates and that effect on bond ETF prices, they may select a bond ETF with a shorter average maturity. Of course, there’s no guarantee that equities and bonds will continue to offer low or negative correlation.

And there you have it. Three ETFs, nine letters, one very simple but likely effective portfolio over the longer term.

Source: http://seekingalpha.com/article/1505922-an-even-easier-dividend-growth-portfolio?source=email_investing_income&ifp=0