Reposted From The Kirk Report:
Many of you have asked me to interview experts whose primary focus and knowledge is trading and investing using exchange traded funds or ETFs. It is my pleasure to offer such an interview with Gary Gordon!
Mr. Gordon is a Certified Financial Planner and president of Pacific Park Financial. He is an SEC-registered investment adviser in California. Mr. Gordon has more than 22 years of experience as a personal coach in money matters including risk assessment, small-business development and portfolio management, and he has taught finance in Mexico, Singapore, Hong Kong, Taiwan and the U.S.
Many of you are already familiar with Mr. Gordon as I’ve often linked to his website, ETF Expert, in which he provides a daily dose of interesting and helpful commentary within the ETF landscape as well as his weekly podcast.
We hope you find this interview helpful in your journey!
Interview With Gary Gordon
Kirk:¬†¬†Please tell us a little more about yourself, Gary.
Gary:¬†¬†Perhaps the most intriguing thing about my background is my intimate familiarity with Southeast Asia. I’ve lived and worked throughout the region, while my personal joy is my “soon-to-be” 15-year old daughter Wei.
After having made a name for myself as a CFP on financial talk radio in the 90s, I went from working for others in finance to working for myself. I’ve been a prominent advocate for ETFs since the very first SPDR.
Kirk:¬†¬†What do you do at Pacific Park Financial? What does a typical day for you look like?
Gary:¬†¬†In essence, I make all of the investment decisions and meet with the clients. I also use the Internet for podcasting and web writing. Managing my time between portfolio management, client meetings and Internet activity consumes the bulk of my personal time. I leave the day-to-day business operations of my Registered Investment Adviser with the SEC to colleagues at Pacific Park.
Kirk:¬†¬†Do you trade/invest any of your own money independently or do you just do this for your clients?
Gary:¬†¬†I invest my money in the exact same manner that I would for my clients. My biggest holdings tend to be the same or similar to their biggest holdings. If there’s any difference, it is simply a matter of risk tolerance and risk appropriateness.
Kirk:¬†¬†In your opinion how does your approach and investment firm offer special value?
Gary:¬†¬†There are only 4 things that can happen in any investment – a big gain, small gain, small loss and big loss. Three of them are good. Simply put, we do not allow big losses to occur. It’s accomplished through stop-limit loss orders, hedges and efforts to combine non-correlating assets.
So what we offer above all else is a measure of protection against downside risk. As for an approach for what to purchase in the first place, I describe the decision as information processing. Fundamentals, technicals, contrarian, historical, seasonal, economic, geopolitical – everything has merit. I gauge the environment for what bit of information may have the most merit, make a decision, and then manage the outcome for a big gain, small gain or small loss – no big losses.
Kirk:¬†¬†There has been a trend of late that many investors are unhappy with their money managers and advisors. To what do you attribute to this, other than market conditions?
Gary:¬†¬†Many are salesman with little formal education. They are told what to invest in by the chain of command or they may try to become “chartists.” Others from the financial planning world (CFP, CFA) where I received training – they fell into the groupthink of fundamental valuation and buy-n-hold. Since buy-n-hold failed and valuation is hotly contested and because some salespeople lack an understanding of what they sell (e.g., broker’s exemption rule), a lost decade isn’t going to win many fans.
I tell clients that you don’t need a stock guru – you need a risk manager. You don’t need a person who rarely has time to chat; you need a person who can talk about your money and what your money is for, when you need him/her. People who want advice require risk managers who are available and who may have an edge in ETF selection through experience/knowledge.
Kirk:¬†¬†What common mistakes do you see when working with new clients?
Gary:¬†¬†Expectations can be an issue. Explaining the importance of cash flow (income stream) when many are conditioned to think only in terms of price appreciation – that can be a challenge as well.
Kirk:¬†¬†Putting your self-interests aside, do you think most people are better served by having their money invested on their behalf by a professional or going the self-directed route?
Gary:¬†¬†This one is very simple. I think many people should invest by themselves and I can teach them how in a very short period of time. Use ETFs, reduce costs wherever possible, do not allow a loss to get out of hand (ever), recognize the power of yield/interest/dividends and invest time in the management of your money.
Now here’s why so many people still need help. They may not have the time that they should be putting towards the activity. They may not have the interest. And most of all, they may get too emotional to make the unemotional decisions (like taking a small loss). A good money manager is as much a manager of emotions as he/she is a manager of assets. What’s more, he/she has the interest as well as the time in the field to address risks and apply knowledge.
Kirk:¬†¬†What steps do you recommend for those seeking professional advice? How do you find someone who can best serve your interests?
Gary:¬†¬†Make sure the person is an independent fee-only adviser. This one is tougher than it looks. Fee-only means assets under management or flat fee arrangement, and it does not mean the person receives a sales commission for working with you. Your adviser should be giving you advice, not selling you advice. Keep in mind; fee-based advisers make money from selling you investments on commission and charging you a fee. It is critical to make sure it is fee-only investment advice.
You should pursue a CFP or CFA. The fiduciary responsibility and the knowledge is critical, and salespeople in money management are not necessarily educated enough. They may not be held to the highest standard of caring for your assets.
Most of all, you have to “click” with the person. Their philosophy needs to make sense to you. If you don’t have rapport, if you don’t agree with the person’s philosophy, it won’t work down the road. If you think actively managing downside risk is important, but the adviser tells you that buy-n-hold is the best long-term approach, you’re not on the same page.
Kirk:¬†¬†If going the self-directed route, what advice do you offer?
Gary:¬†¬†Again – use ETFs, reduce costs wherever possible, do not allow a loss to get out of hand (ever), recognize the power of yield/interest/dividends and invest time in the management of your money. What’s more – read a ton!
Kirk:¬†¬†How did you first get interested in the markets?
Gary:¬†¬†Not counting the high school intrigue of the WSJ (I grew up in New York); I took a year off in my 3rd year of college to live in Taiwan (Republic of China) in 1987. It turns out, that was the first year that Taiwan opened its markets to the outside world and it was one of the best performing markets that year. It also turned out; the world experienced the ‘87 crash. I was hooked. And I began developing an approach to investing that countered buy-n-hold-n-hope for the best.
Kirk:¬†¬†Is there anything you’ve learned recently that would have surprised you just a few years ago?
Gary:¬†¬†Honestly, not a lot surprises me. The fact that it took 4 years between Greenspan uttering “irrational exuberance” and the dot-com balloon to burst was far more surprising than the NASDAQ implosion itself. About the only thing that surprises me are those who still think it is smarter to buy-and-hold a 60-40 stock bond portfolio, rather than recognize that risk is measured on the downside. After all, things do change. U.S. treasuries aren’t exactly endorsed as risk-free assets by everyone anymore. I’d rather hold SE Asia local debt.
Kirk:¬†¬†What are some of the key lessons you’ve learned over the last two decades of your career?
Gary:¬†¬†Invest in yourself first and then explore other assets. Look for every possible tax advantage, though not at the expense of sound investing/saving principles. Remember the reason you invest and it’s probably not “winning.”
Kirk:¬†¬†What would you say are your primary strengths as an investor?
Gary:¬†¬†Perhaps the biggest strength is a keen understanding of the primary emotions – greed and fear. My masters in Psychology gave me a leg up on that. Not only do greed and fear move markets, which is critical for assessing the possibility of everything from panics to bubbles, but the understanding helps me communicate with clients. The conservative investor always seems to crave a little more moderate risk when markets are moving higher…the aggressive investor usually downshifts to a moderately conservative person during times of market stress. Understanding emotionality and removing emotions from the “sell decision” serve as primary strengths.
Kirk:¬†¬†What about your weaknesses?
Gary:¬†¬†I have far more failings as a human being than I do as an investor. That is to say, as a person, I can exhibit a New York attitude (born and raised), or I can be super-lazy at the gym, or I may not call Mom as often as I should. As an investor, however, I use a wide range of data to make the best possible decision that I can. After that, I mechanize the process to remove any emotional attachment, so that the outcome is a small gain, large gain or small loss. I wholeheartedly believe that this is the best way to invest, removing the risk of a large loss on any one decision.
Kirk:¬†¬†How would you describe your personal philosophy toward the market?
Gary:¬†¬†I tell people that the market, or markets, will drive you crazy if you try to predict them. Focus instead on the things that are within your control. You can‚Äôt control oil prices, interest rates, government action or inaction, earnings expectations, unemployment data, market manipulation. What can you control? As I have said, you can control the outcome of every investment decision so that you never suffer a large loss. You can control the passive income such that the higher the yield/interest/dividends, the higher your returns. And you can control costs such that, the lower your costs, the higher your returns. ETFs give you more control over yield, costs, and outcome than any other market access vehicle.
Kirk:¬†¬†In your view, what are the primary benefits of using ETFs?
Gary:¬†¬†Liquidity/trade-ability, tax-efficiency, low-cost indexing. In essence, you need an “exit strategy” to manage risk effectively. ETFs give you that trade-ability to reap the rewards of low-cost diversification via indexing. ETFs represented the low-cost indexing required for limiting the downside risk associated with the dot-com blow-up of 2000-2002 and the credit collapse of 2008.
Kirk:¬†¬†What are the clear negatives to ETF-focused approaches?
Gary:¬†¬†ETFs can’t always capture the unique alpha presented by, say, an Altria (MO) or an Apple (AAPL). Diversification of access through individual holdings, ETFs and mutual funds can have value. Commodity ETFs often struggle with getting investors close to a theoretical spot price, but there are times when an investor shouldn’t even be interested in spot prices.
Some ETFs simply do not trade enough, and the wide bid-ask spread causes additional costs, not to mention difficulty in executing a stop-limit sell order. Yet, by and large, if you believe that costs, yields, and controlling the outcome (big gain, small gain, small loss only) determine success, ETFs are the way to go.
Kirk:¬†¬†What are your favorite tools when searching, tracking, and evaluating ETFs?
Gary:¬†¬†ETFScreen currently offers the best tracking of relative strength, momentum and other technicals. Sometimes, you have to go directly to the provider’s site to get the latest fundamental data.
Kirk:¬†¬†Is there a certain volume threshold an ETF must clear before you would consider trading/investing with it?
Gary:¬†¬†Daily dollar volume must exceed $250,000
Kirk:¬†¬†In what cases do you think using leveraged ETFs can be justified?
Gary:¬†¬†I only use them as trading tools or hedges, primarily in taxable accounts.
Kirk:¬†¬†What’s your view on actively managed ETFs?
Gary:¬†¬†While there are exceptions in the income arena and alternative asset arena, I do not like active stock ETFs. One of the premier benefits of stock ETFs is the tracking of a passive index. Passive index tracking gives exposure to a desired area at the lowest cost and greatest tax-efficiency, as most indexes do not rebalance more than a few times per year. If you really believe an active stock picker adds value, study the closed-end funds with high volume (CEFs).
Kirk:¬†¬†In recent years are there any new ETFs you consider to be particularly beneficial for investors and worthwhile to consider?
Gary:¬†¬†In the income arena, WisdomTree Asia Local Debt (ALD) and WisdomTree Emerging Market Local Debt (ELD) are important. While other foreign bond offerings have been around for a while, they have been dollar-denominated. If you believe the dollar will continue to lose value to emerging world currencies, these local debt funds are worthy of consideration.
In the stock arena, index-trackers in areas that one may not have previously had access to are worthy of consideration. Chile (ECH) and Poland (EPOL) and New Zealand (ENZL) come to mind when you think of the iShares brand, heck – even the Philippines (EPHE).
Kirk:¬†¬†Please take us through the various steps of how you would evaluate a new ETF’s prospects compared with others?
Gary:¬†¬†Here’s a recent example you may find helpful to read and review.
Kirk:¬†¬†How important is a particular ETF’s holdings and allocations to you in this evaluation process?
Gary:¬†¬†It’s absolutely critical to understand the difference between what’s advertised and what’s inside. There are country/regional ETFs that have/had 65% dedicated to the financial sector, and that didn’t go over well in the 2008 collapse. In contrast, there are country funds that might as well serve as a proxy for a global sector, like South Africa (EZA) and iShares Global Materials (IXN). If you know what’s inside, and if you track price movement, you’re able to better diversify your portfolio.
Kirk:¬†¬†How much do expenses and tax burdens weigh on your evaluation?
Gary:¬†¬†One of the few fundamental truths in investing is this – the lower your cost to invest, the higher your returns. Expense ratios matter. Vanguard exchange-traded index funds often outperform Blackrock/iShares on the same index primarily due to lower cost. Tax-efficiency is also important, but more so, when the investment is going into a taxable account.
Kirk:¬†¬†Within your client portfolios, what are the top ETFs that you use the most in your clients’ portfolios?
Gary:¬†¬†For beta access, VTI, VWO, GLD, IJH, VNQ, CIU, XLE, GCC, HYG, PFF
For preference at a given time for a given reason? SDY, AMJ, VIG, DEM, GXC, EWM, IWF/IWS.
Kirk:¬†¬†Are there any rules of thumb you like to go by regarding how many ETFs should be held in any of your clients’ portfolios?
Gary:¬†¬†Assuming the cost of trading isn’t free, you might diversify small portfolios more if there are no trading costs. But, here is an general guide based on available capital:
- $50,000-$75,000, 6-8 ETFs
- $75,000-$150,000, 8-11 ETFs
- $150,000-$250,000, 12-14 ETFs
- $250,000-$500,000, 14-16 ETFs
- $500,000-$1,000,000, 16-18 ETFs
- $1M+, Depends
Kirk:¬†¬†Why does the amount of available capital determine the number of ETFs?
Gary:¬†¬†As more custodial firms offer free ETF trading, it doesn‚Äôt necessarily have to. AT TD Ameritrade where 100+ ETFs trade for free, you could have a mere $36,000 in an account, and use 12-15 ETFs at no trading cost. One probably doesn‚Äôt need this much diversification when it is early in their investing lifespan, but it can be done. However, $8 or $10 per trade would be too costly on small account and in my view mutual funds are typically better for small accounts.
Moreover, smaller accounts do not typically represent the entirety of a person‚Äôs life work or savings and investment. It follows that as you’re building your asset base, you aren‚Äôt in need of as much diversification across currencies, commodities, preferreds, MLPs, convertibles, common stock, foreign, large, small. If you have a small account, you might sum up your needs in a handful of stock and bond ETFs, and an occasional “I‚Äôve got a feeling.” Just control the risk of being wrong.
Kirk:¬†¬†Can you provide us an example of a client’s portfolio as a teaching example of what you consider a solid, very well-structured portfolio?
Gary:¬†¬†Since I am adamantly opposed to buy-n-hold it follows that a well-structured portfolio may be well-structured today and poorly structured tomorrow. Personally, I monitor asset correlations, trend changes, greed, fear.
I do think you can begin with a set of ETFs that you would use for basic stock and commodity access. One may need to remove them from his/her portfolio when protecting against downside risk, but again…
Here is what I might be using for basic beta when a given asset class is trending higher and/or fundamentally attractive:
- Total US (VTI)
- Emerging Markets (VWO)
- Gold (GLD)
- Total Commodity (GCC)
- Total REIT (VNQ)
- High Yield Bonds (HYG)
- Investment Grade Corporates (CIU)
- Mid Cap US (IJH)
- Preferred Shares (PFF)
Now you add assets that you‚Äôve identified as low-correlating and/or diversifiers. This set is much more extensive as it includes large vs small, growth vs value, foreign vs domestic, sectors, sub-sectors and so forth.
I gave the example of these assets in a previous answer to a question (SDY, AMJ, VIG, DEM, GXC, EWM, IWF/IWS). The point is you might have a reason to consider dividend aristocrats (SDY) or dividend growth (VIG), large growth (IWF) or mid value (IWS), emerging market dividends (DEM) or specific emerging markets (EWM, GXC).
So for me, at a given moment in time, here is a portfolio that could work nicely for a moderate growth investor with $240,000. CIU, FXC, HYG, PFF, VTI, VWO, GLD, GCC, IWS, DEM, EWM, IHI.
Kirk:¬†¬†Thank you. That’s helpful.
What is your view regarding using ETFs in passive portfolios? Is this a legitimate strategy to consider when investing in the market for an average investor?
Gary:¬†¬†Passive buy-n-hold mutual fund investors can set up equally appealing, possibly more appealing, and passive ETF portfolios. I do not believe passivity is the best way to go, though. Passive indexes, yes. Passive with respect to attending to risk and opportunity? That is very foolish in my opinion.
Kirk:¬†¬†Where do you think the ETF industry is headed over the next few years? In your opinion, Gary, what future products can we expect ETF managers to develop?
Gary:¬†¬†Active ETFs will continue to be the largest area of growth, though it does not interest me, and few will be more beneficial than Traditional Exchange-Traded Index Funds. Enhanced intrigue in commodities ensures efforts to produce ETPs that come closer to spot, for expectation purposes alone. There will be more small and mid-cap funds for key countries and regions, value and growth as well. But at some point, over saturation all but ensures industry consolidation. Vanguard, State Street and Blackrock iShares may gobble up a few of the 2nd or 3rd tier players, while a few companies will simply go belly up.
Kirk:¬†¬†Are there any resources (books, websites, etc.) you recommend on learning more about ETF-focused investing?
Gary:¬†¬†Honestly, most of the books tend to be outdated or geared to buy-n-holders. Web sites will get you up to speed faster, sites like Seeking Alpha. One of my personal favorites is ETFScreen. It is a great site for investors to sink their teeth into – the data is outstanding, timely and free.
Kirk:¬†¬†Finally, do you have any parting words of wisdom to share for those looking to improve their returns for the second half of the year?
Gary:¬†¬†Keep it simple. Don’t outsmart yourself. Don’t over-think what you are trying to accomplish.
If the markets are trending higher, and you’re invested, the majority of your positions should reflect that (a la beta). Then you can surround your core holdings with a theme (e.g., reflation) or a sector overweight (e.g., technology).
Adhere to a simple methodology for managing downside risk; whether it is stop-limit sell orders or 200-day moving averages. Have an exit plan for any eventuality.
My crystal ball may tell me that investors/traders want the markets to succeed in 2011, and they will likely buy the dips of any corrective period this year. But good money managers don’t play around with the risk of a big loss. In brief, make sure anything you ever choose, for however long you own it, results in a big gain, small gain or small loss – just absolutely no big losses!
Kirk:¬†¬†Thank you, Gary!