When ETFs Attack: Using Diversification to Your Advantage

Most of the week, the media have been hell-bent on exploring Dow 14000. After all, who wants to hear about currencies or commodities when stocks are notching record highs?

You want to hear about other asset classes! Why? Because exchange-traded funds track indexes of stocks, bonds, currencies, commodities and real estate investment trusts. (And that means... you can make sure that you are properly diversify your overall portfolio.)

Today, we watched the Dow and S&P 500 give up more than 1% in value in a single trading session; 14000 one day, 13850 the next. Yet a diversified portfolio would not necessarily suffer 1% losses.

For instance, if you held the S&P 500 SPDR (SPY) exclusively, or if you surrounded your core holding with highly correlated assets like the Financial Select Sector SPDR (XLF), you would suffer at least as much as the broader stock market; that is, you would experience a 1%-1.5% portfolio loss... and it would not have been in your best interest.

Your best interest is to use assets that do not correlate that highly with one another... assets that zig when others in your portfolio zag. The lowest correlating equity asset to the S&P 500 is the Energy Select Sector SPDR (XLE). It might surprise you to note that XLE only fell 0.47% today.

There are assets with even more zig for the opposing zag. For example, the CurrencyShares Australian Dollar Trust (FXA) was up a "skohsh" with .01%. Equally important, FXA has earned stock like returns of 13.6% in 2007, where there is significantly less volatility in the Australian dollar than US stocks. (And a mighty fat dividend for participating.)

So you get true diversification with the CurrencyShares Australian Dollar Trust (FXA). You get performance, yield, lower volatility... why wouldn't it be worth a look?

One last "diversifier" on my list is the iPath Dow Jones-AIG Commodity Index (DJP). This all-purpose commodity investment may have a less robust 6.5% gain in 2007, though that is still pretty sharp for 6 1/2 months. More importantly, on a day like today, when stocks rapidly heading south, it's nice to see an uncorrelated DJP do its own thing. (Even if its own thing was a smaller loss of 0.57%.)

The larger point? If your core portfolio holding of the S&P 500 SPDR (SPY) is surrounded by the likes of uncorrelated "diversifiers" like XLE, FXA, and DJP, your portfolio will not struggle as badly as the stock market. And believe me, the stock market will have its corrections and bears... so think about diversifying!

Disclosure Statement:  As a Registered Investment Advisor, Pacific Park Financial, Inc. may hold positions in the ETFs, mutual funds and/or index funds mentioned above.