ETF Expert

I get a huge kick out of the banter back and forth between Hougan and Wiandt at Index Universe. They publicly disagree with one another in numerous financial columns. Yet, it never comes off as malicious.

In fact, the principals at Index Universe obviously have great respect for one another. What's more, if you read between the lines of their "info-tainment," you get the impression that they have more in common than the online debates might otherwise suggest. Namely… these folks love exchange-traded funds (ETFs).

However, a recent post by Mr. Wiandt left me wondering if I too shouldn't play devil's advocate. In brief, the columnist puts forth the idea that anyone who might have liked the Dow Jones Industrials Diamond(DIA) at $100… should love it at $71.

In a rough approximation, DIA at $100 is Dow 10000, whereas DIA at $71 is Dow 7100. And in a relative sense, sure… anyone who made a mistake of buying and holding the Dow near 10000 would sure like to have bought in at 7100 instead.

Still, let's take a step back at what one should or shouldn't love. Just because the Dow Diamond (DIA) is down 50% off of its high, does this make it lovable? The same question can be asked of the broader S&P 500 SPDR (SPY)… lovable at 50% below its peak?

I'm not so sure… and here's why.

In March of 2000, the Powershares Nasdaq 100 (QQQQ) hit an intra-day high near 120. In February 2001, just one year later, the Qs were trading 50% lower around 60. Radio show listeners called me… media writers e-mailed me… isn't this a steal? (Having warned so many listeners, clients and readers about the 2000 stock bubble, there was a lot of interest in my opinion on the Qs.)

In truth, I thought 50% down might just be a decent entry point. But in every instance where someone might inquire, I said the same thing. "There are no rules about how low an index might go. So just make sure you have a comfortable stop-loss that you can live with. If you buy at $60, maybe your stop is 20% lower at $48. After all, there's no rule that says the Qs won't go to 30."

Historical note: The Nasdaq 100 (QQQQ) dropped below $20 in October of 2002… and the ETF has never come close to recovering the $60 level. In October of 2007, it barely touched $50.

Granted, Mr. Wiandt cautioned against trying to catch a falling knife. He prefers the S&P 500 (SPY) to the Dow Diamond (DIA). Moreover, he suggests incremental purchases to nibble on at these prices and/or waiting until an index has climbed 20% off of the bottom before allocating with more conviction.

Nevertheless, that approach hasn't been fool-proof either. The S&P 500 SPDR Trust (SPY) rose 24% from $74 on November 20, 2008 to $94 on January 6, 2009… only to give it all back and more. (SPY recently traded at a low of $70.8.)

Stop-losses are not the solution to all one's investing concerns. You will sell when you didn't necessarily benefit. And you still need an approach for deciding what and when to buy.

However, buy-n-hold investing is a recipe for disaster. You must have an approach for when to buy AND when to sell. It's about true risk management; it's about insurance… accepting a smaller loss (premium) to avoid a bigger catastrophe.

As an investor, you're going to make scores of mistakes. I've made plenty. But if there's one thing that a "bad call" or "poor decision" should teach you… make smaller mistakes!

Nothing in the world of investing is sacrosanct. So question old wisdom, new ideas… question it all. And if you choose to purchase the Dow Diamond at a lovable $71 ($68 as I type), consider a stop at $56. After all, there's no rule that says it won't go to $35.

If you'd like to learn more about ETF investing… then tune into "In the Money With Gary Gordon." You can listen to the show "live" or via podcast or on your iPod at this link.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.