The Wisdom of Avoiding The Big Loss

I have a confession. I believe that, when it comes to investment returns, dividends are more important than a company's size.

The returns of dividend-based indexes versus market-cap weighted indexes usually speak for themselves. In the 10-year period ending 12/31/2006, the Wisdom Tree Dividend Index annualized at 11.35% whereas the Russell 3000 Index annualized at 8.64%.

Not surprisingly, then, I favor the Wisdom Tree exchange-traded fund family. Wisdom Tree has a variety of U.S. and international ETFs where the indexes rely on dividend-paying companies. Small, medium or large-sized companies with the highest dividend yields, in the U.S. and abroad, comprise many of the Wisdom Tree indexes.

Recently, one of Wisdom Tree's chief founders, world-renowned author (Stocks for the Long Run) and uber-professor, Jeremy Siegel, released his personal portfolio. It's a buy-n-hold-n-hope portfolio with the belief that the investments will perform exceptionally well over the "long run."

Holdings are as follows:

Wisdom Tree Total Dividend Index DTD
Wisdom Tree Earnings Index EXT
Wisdom Tree DEFA Index DWM
Wisdom Tree High-Yield Equity Index DHS
Wisdom Tree DEFA High-Yield Equity Index DTH
Wisdom Tree International Energy Sector Index DKA
Wisdom Tree International Non-Cyclical Index DPN
Wisdom Tree Low P/E Index EZY

As much as I love many of the good professor's selections, particularly DTD for U.S. exposure and DTH for Eurpoean exposure, I shudder to think what would happen to this 100% allocation in a severe downturn.

For instance, if one had $1,000,000 at the start of the year 2000 invested in this portfolio, one may have been looking at $700,000 by the end of 2002 (hypothetical losses). The 30% loss over 3 years would then require at least the next 2 years to get back to the starting gate.

Exchange-traded index funds, particularly those based upon dividends, provide lower-cost diversification and superior returns to traditional mutual funds. Yet it does not make sense to lose 30% of your money nor spend 5 years getting back what you lost.

There are only 4 practical outcomes for any investment you may have -- a big gain, a small gain, a small loss and a big loss. 3 of those outcomes are good; that is, only a big loss can hurt you.

Use the ETFs that Jeremy Siegel suggests. Hold them for as long as they make sense for your investment picture. Yet true wisdom resides with the investor who protects his/her ETF portfolio with stop orders. That way, you will never have to worry that your $1,000,000 becomes $700,000.

Disclosure statement: Some of Pacific Park’s investment clients may hold positions in any of the investments mentioned above.