Purge explosive ETFs And Other Tips For 2018

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We recently shared three investment resolutions for a richer 2018. Today, we present four more ways to grow your wealth next year.

1. Get to know your financial advisor better (if you have one at all!)

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If you use an investment or financial advisor (and – just to be clear – I firmly believe that most people can take care of their own finances and do not need a financial advisor… in fact, that’s one of the reasons we founded Stansberry Churchouse Research), make an appointment with him or her in the new year to ask a few questions – especially about how they get compensated, if you don’t already know.

Are they purely commission-based salespeople? Do they charge an annual percentage based on the value of the assets they manage? Is it a flat annual fee?

Then ask about how much you paid in fees over the past year. Was the advice you received worth it? If you feel your advisor has earned the fees, great. If not, take stock of the relationship.

Also find out if they’re governed by suitability or fiduciary rules. It can have an impact on the quality of advice and the fees you’re paying. You can read more about the difference between suitability and fiduciary rules here.

2. Give your portfolio some balance

Global markets have had a good year, and most major stock markets are up, which means you might have some investments that have done well. That means it’s time to rebalance.

When I say “rebalance,” I mean realigning the portion of each asset in a portfolio. In other words, selling “winning” assets that have increased their share of the portfolio since it was first created – and replacing them with other assets to balance out the risk.

Rebalancing is one of the most overlooked parts of an investing strategy. But it’s also one of the most important.

For example, picture a portfolio where 50 percent is invested in stocks, 30 percent is in bonds, 10 percent is in real estate and the rest is in cash.

Now imagine that over the next 12 months, stock markets go gangbusters and are up 20 percent – while bond markets plod along and earn you 2 percent. Because of this big difference in performance, stocks now make up a larger proportion of your portfolio than before.

In other words, the portfolio is now less diversified – and more at risk.

That’s because significantly more of the portfolio is now invested in one asset class than originally intended. So if the stock market crashes it will have a bigger effect on your portfolio.

Left unchecked, a diversified portfolio can become unbalanced through performance. And it can happen without investors even realising.

So here are three basic strategies to keep a portfolio in check:

1. Time: a portfolio is rebalanced after a specific period… once every six months or year, for example. Most passive investors use “calendar rebalancing” – checking their asset allocations on an annual basis to make sure it still meets their investment goals and appetite for risk.

2. Threshold: investors set a limit, similar to a stop-loss level, to prevent one asset drifting too far from its original allocation and rebalance once it reaches this limit (five percent on either side of the target, for example).

3. Time and threshold: as the name suggests, this is a combination of the first two strategies. The portfolio is checked at regular intervals, but isn’t rebalanced unless one of the assets has reached its predetermined threshold.

Following these strategies will protect you from emotions that can lead to bad financial decisions (as we’ve written before). And help you make the most of diversification.


3. Purge explosive ETFs

Sell leveraged and inverse ETFs, which are the financial world’s version of weapons of mass destruction.

A leveraged ETF attempts to track a multiple of the performance of an index. For example, SSO (the New York Stock Exchange-traded Ultra S&P 500 ETF) says that it aims to return 2 times the S&P 500 Index. So if the S&P 500 Index rises 1 percent in a day, SSO returns 2 percent. (And if the S&P 500 falls 1 percent, SSO falls 2 percent.)

Inverse ETFs do the opposite of what an index does – if the S&P 500 falls 1 percent, SH (the Short S&P 500 ETF) rises 1 percent (and if the S&P 500 rises 1 percent, SH falls 1 percent).

Both inverse and leveraged ETFs use derivatives to do this. Derivatives are instruments that “derive” their value from an underlying asset. For instance, you can buy a derivative that will be valued based on how the price of gold or a stock index performs.

The problem with these types of ETFs is that they don’t always work like they’re expected to.

Here’s an example to illustrate: Let’s say you buy a 2X leveraged ETF that tracks the return of ABC index. You buy one share of the ETF for US$100, and the underlying index is at 10,000.

If ABC jumps 10 percent the next day to 11,000, your 2X leveraged ETF would increase 20 percent, to US$120. But say the next day the index drops from 11,000 back down to 10,000. That’s a 9.09 percent decline for the index. But your 2X leveraged ETF would go down twice this amount, or 18.18 percent.

Losing 18.18 percent means the value of the leveraged ETF would drop from US$120 to US$98.18. So, over the two-day period the underlying ABC index is unchanged – it started at 10,000 and is back at 10,000. But the value of your 2X ETF is down 1.82 percent!

Now, if the underlying index rises every single day for an extended period, you will earn great returns. But any down days will hurt a leveraged ETFs performance (relative to the underlying index) by more than you’d expect.

That’s one reason why it’s best to avoid these types of ETFs. You could get the trend right… and lose money anyway.

4. Buy a little bitcoin

Given bitcoin’s recent surge higher, you might think you’ve missed the boat on bitcoin. Or the volatility in the crypto space might be keeping you away. But regardless of the incredible volatility and wild west nature of this space, we believe that everyone should own some bitcoin.

You see, bitcoin is here to stay. And what’s more, so are cryptocurrencies. Blockchain – the technology behind bitcoin – is game changing… and has the capacity to not only reinvent existing business models, but to completely upend traditional capital markets and business structures as we know them.

The most appropriate course of action for the majority of investors is simply to buy a little bitcoin – and forget about it. Buy, hold and ignore the volatility. Participate financially, not emotionally. It’s not a one-way ride, and it’s a bumpy one. Be prepared to stomach big declines and sit tight. And “invest” no more than you can absolutely afford to lose.

Bitcoin is an asymmetric bet… if it falls or even goes to zero, your loss is small (assuming you’ve put in only what you can afford to lose). But if over the next few years it continues go up, then gains of 4 to 10 times are entirely possible… and even bigger gains lie outside of bitcoin in the cryptocurrency space. There is no other asset class on earth that offers this kind of return profile.

In short, everyone needs to familiarise themselves with the process of buying, trading and storing cryptocurrencies. They’re here to stay. And being on the outside (and not understanding them) will limit your ability to profit from them.

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